free movement of capital, company law and … · 3 1. executive summary the international...

EUROPEAN COMMISSION Internal Market and Services DG FREE MOVEMENT OF CAPITAL, COMPANY LAW AND CORPORATE GOVERNANCE Accounting

Brussels, 24 November 2008 MARKT F3 RB D(2008)

Endorsement of revised IFRS 3 Business combinations

and amended IAS 27 Consolidated and Separate Financial Statements

Introduction, background and conclusions

2

TABLE OF CONTENTS

1. EXECUTIVE SUMMARY......................................................................................... 3

2. BACKGROUND......................................................................................................... 4

2.1. The business combinations issue....................................................................... 4

2.2. History of the IASB project .............................................................................. 4

2.3. Main changes made to IFRS 3 and IAS 27 ....................................................... 5

3. OVERVIEW OF STAKEHOLDER CONSULTATIONS ......................................... 7

3.1. IASB consultation process ................................................................................ 7

3.2. EFRAG consultation process ............................................................................ 7

4. EFFECT ANALYSIS.................................................................................................. 8

4.1. Methodology ..................................................................................................... 8

4.2. Analysis of main issues in IFRS 3R.................................................................. 9

4.2.1. Contingent considerations ................................................................... 9

4.2.2. Acquisition-related costs ..................................................................... 9

4.2.3. Step acquisitions................................................................................ 10

4.2.4. Partial acquisitions - less than 100 percent ...................................... 10

4.2.5. Definition of a business..................................................................... 12

4.2.6. Fair value as a measurement attribute ............................................... 12

4.2.7. Scope ................................................................................................. 13

4.3. Analysis of main issues in IAS 27A................................................................ 14

4.3.1. Changes in ownership interest that do not result in control of another entity being lost .................................................................... 14

4.3.2. Changes in ownership interest that result in control of another entity being lost ................................................................................. 14

4.3.3. Accounting for losses attributable to NCI......................................... 15

5. OVERALL COST-BENEFIT CONSIDERATIONS................................................ 16

6. COMMISSION SERVICES' CONCLUSION .......................................................... 16

ANNEX 1 EFRAG Effect Study Report

ANNEX 2 EFRAG Endorsement Advice on IFRS 3R

ANNEX 3 EFRAG Endorsement Advice on IAS 27A

ANNEX 4 IASB Project summary, feedback and effect analysis

3

1. EXECUTIVE SUMMARY

The International Accounting Standards Board (IASB) published a revised International Financial Reporting Standard 3 (IFRS 3R) Business Combinations and an amended International Accounting Standard 27 (IAS 27A) Consolidated and Separate Financial Statements, in January 2008. They replace IFRS 3 Business Combinations (endorsed for use in the EU in December 2004) and amend IAS 27 Consolidated and Separate Financial Statements (endorsed for use in the EU in September 2003 with amendments endorsed in December 2004), which are currently applicable pursuant to Regulation 1606/2002/EC (IAS Regulation).

For both, IFRS 3R and IAS 27A, EFRAG recommended the European Commission adoption for use in the EU (please see EFRAG endorsement advice ANNEX 2 and 3).

This effect study report analyses the potential effects of adopting the revised IFRS 3 (IFRS 3 R) and the amended IAS 27 (IAS 27 A) in the European Union (EU). It focuses on key issues raised in the context of the IASB and European Financial Reporting Advisory Group (EFRAG) consultations. It takes into consideration the main conclusions regarding potential effects reached by EFRAG in the Effect Study Report as finalised in November 2008 (see ANNEX 1) and the IASB in the Project Summary, Feedback and Effect analysis published in January 2008 (ANNEX 4). It concludes that the adoption of IFRS 3R and IAS 27A would have positive cost-benefit effects. In particular, the report concludes that:

• The revised standards will result in benefits for preparers by improving the underlying principles compared to the existing standards and by adding guidance in areas where the existing standards have been not sufficiently clear or silent. The amendments are not expected to create significant additional costs for preparers as no significant changes to accounting systems will be necessary. However, some additional preparers' costs may arise from the requirement to measure previously held interest at fair value for a step acquisition. Nevertheless, these changes are expected to reduce overall preparation costs.

• The revised standards will result in benefits for users by improving comparability over time and increasing the relevance of information provided. It will also facilitate the comparison between IFRS financial statements and US GAAP financial statements. In order to arrive at the same standard in IFRS and US GAAP, the bigger amount of the changes in this phase of the project had to be made to the US Standard. As a consequence, the European users that are familiar with IFRS will face only limited costs to adapt to the revised standard.

• The Commission Services welcomed the announcement by the IASB in January 2008 of an effect study on IFRS 3R and IAS 27A to identify and evaluate the main costs and benefits for users and preparers. This was the first effect study of that kind published by the IASB to meet stakeholders' requirements to have their views considered prior to the issuance of a new or revised standard. The Commission Services have also noted the intention of the IASB to carry out a post implementation review after two years of implementation of the revised standards. Such a review should particularly look into the eventual costs and implementation problems encountered during the implementation phase.

4

The Commission, based on the recommendations received and the outcome of the effect studies carried out, concluded that the revised IFRS 3 and the amended IAS 27 should be endorsed in the European Union because they meet the criteria for endorsement as provided by the IAS Regulation 1606/2002 and the benefits of endorsement will outweigh the costs.

2. BACKGROUND

2.1. The business combinations issue

In 2006, more than 13.000 mergers and acquisition (M&A) transactions took place worldwide. Almost 50% of the transactions, reflecting a combined value of 1,03 trillion Euros, were accounted for using US GAAP and most of the remainder, reflecting combined value of 1,26 trillion Euros, were accounted for using IFRS or accounting frameworks converging to IFRS. Over the last decade the average annual value of corporate acquisitions worldwide has been the equivalent of 8-10% of the total market capitalisation of listed securities1.

Investors and their advisors have to assess how the activities of the acquirer and its acquired business develop following a business combination. Due to the complexity of business activities this is a challenging exercise. Comparisons on a European or even global level are less burdensome if the information is based on a common accounting framework. The removal of differences between US GAAP and IFRS in that respect will contribute to ease this assessment and will improve the comparability and the understanding of the effects of a business combination by the users.

According to the IASB view, the core principle governing accounting standards dealing with business combinations is defined as follows: "An acquirer of a business recognises the assets acquired and liabilities assumed at their acquisition-date fair values and discloses information that enable users to evaluate the nature and financial effects of the acquisition."2 This project was put on the agenda as part of the global convergence project agreed between the IASB and the FASB3. The aim is to unify M&A accounting across the world.

2.2. History of the IASB project

Prior to 2001, business combinations under International Accounting Standard (IAS) were governed by IAS 22 that was revised in 1998. Following the adoption of SFAS 141 by the FASB in 2001, the replacement of the goodwill depreciation by an impairment test and the removal of the pooling of interest method, there was an increasing pressure from companies applying IFRS complaining about the competitive disadvantages compared to the companies applying US GAAP and requesting the IASB to replace goodwill amortisation with an impairment only approach.

1 IASB: Project summary, feedback and effect analysis January 2008, Overview section, page 4.

2 IASB: IFRS 3 Business combinations, Introduction IN5, page 7.

3 Memorandum of Understanding on convergence between IFRS and US GAAP signed by the IASB and the FASB on February 27, 2006.

5

In order to address these stakeholders' concern, the IASB decided to add the business combinations project on its active agenda scheduled in two phases:

• The first phase focussed on the short term issue: the pooling of interest method and the removal of goodwill depreciation that resulted in the publication of IFRS 3 in 2004 and its endorsement in the EU.

• The second phase aimed at taking a broader view at business combination accounting and at unifying the accounting treatment at a worldwide level. For this second phase, the IASB and the FASB agreed to work together and to pool their resources as both Boards considered that it was the most effective method to eliminate as many as possible of the differences between IFRS and US GAAP.

The IASB concluded its first phase of the project in March 2004 by issuing the currently endorsed version of IFRS 3 Business Combinations. The revision of IFRS 3 and the amendment of IAS 27 in January 2008 is the result of the completion of the second phase of this business combination project. The main focus was on areas for which there was insufficient or no guidance and the examination of the requirements of IAS 22 that were carried forward into IFRS 3 without reconsideration. IFRS 3R was approved by 11 Board members voting in favour and 3 Board members dissenting. IAS 27A was approved by 9 Board members voting in favour and 5 Board members dissenting.

It is our view that in order to further converge relevant accounting standards in IFRS and US GAAP the move that had to be made in the US is by far bigger than under IFRS. Therefore, the changes introduced by IFRS 3R compared to the earlier version have a bigger impact on US GAAP preparers than on IFRS preparers.

IFRS 3R shall be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 July 2009. The amendments made to IAS 27 shall be applied for annual periods beginning on or after 1 July 2009.

2.3. Main changes made to IFRS 3 and IAS 27

The revised IFRS 3 and amended IAS 27 introduce a number of changes to the existing standards but also incorporate many changes compared to the exposure drafts made as a result of re-debating the proposals in the light of comments received during consultations. The main changes are:

• Step and partial acquisitions

The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating the portion of goodwill arising on each step has been removed. Instead, goodwill is measured as the difference at acquisition date between the value of any investment in the business held before the acquisition, the consideration transferred and the net assets acquired.

6

For a business combination in which the acquirer achieves control without buying all of the equity of the acquiree, the remaining (non-controlling) equity interests are measured either at fair value or at the non-controlling interests’ proportionate share of the acquiree’s net identifiable assets. Previously, only the latter was permitted. Allowing this choice was a change from the proposal that was made in response to concerns expressed by many respondents.

• Transparency and comparability

Acquisition-related costs must be accounted for separately from the business combination, which usually means that they are recognised as expenses (rather than included in goodwill).

An acquirer must recognise at the acquisition date a liability for additional consideration (contingent consideration). Changes in the value of that liability after the acquisition date are recognised in accordance with other IFRS, as appropriate, rather than by adjusting goodwill. The disclosures required to be made in relation to contingent consideration have been enhanced.

• New guidance to address divergence in practice

Requirements have been added to specify that changes in a parent’s ownership interest in a subsidiary that do not result in the loss of control of the subsidiary must be accounted for as equity transactions, remedying a deficiency in the existing IAS 27.

Existing requirements for how the acquirer accounts for some of the assets and liabilities acquired in a business combination that have been problematic have been clarified – replacing the acquiree’s share-based payment awards; being indemnified by the seller; rights such as franchise rights, that the acquirer had sold to the acquiree previously and are part of the business combination; embedded derivatives; cash flow hedges and operating and financial leases.

• Other changes

The scope has been broadened by business combinations involving only mutual entities and business combinations achieved by contract alone. This should ensure that the accounting for an important part of M&A activities for which there have been no IFRS requirements before will be consistent with the accounting for other M&A activities.

An inconsistency in the existing IAS 27 has been removed by requiring that an entity must attribute a share of any losses to the non-controlling interests even if this results in the non-controlling interests having a deficit balance.

Requirements have been added to specify how, upon losing control of a subsidiary, an entity measures any resulting gain or loss and any investment retained in the former subsidiary.

7

3. OVERVIEW OF STAKEHOLDER CONSULTATIONS

3.1. IASB consultation process

Prior to issuing its joint exposure draft with the FASB in June 2005, the IASB performed several consultations including 28 public Board meetings, 3 joint public board meetings with the FASB, public meetings with industry groups and other interested parties as well as 44 field visits to entities in seven different countries.

The exposure draft was open for comments until the end of October 2005 and received 283 comment letters. After the end of the comment period on the exposure draft, the IASB and the FASB organized 5 public round table meeting in Norwalk, Connecticut and in London that involved the participation of about 50 organisations from around the world.

Following these debates, the IASB staff for the first time in IFRS standard setting performed an effect analysis to test the impacts of the revision of the standards.

The conclusions of the IASB study are:

(a) for preparers, preparation costs will be reduced, as preparers will be provided with clearer principles to follow. This will be the case regardless of whether the acquisition is a one-step 100 per cent acquisition or a partial or a step acquisition (although in a partial acquisition, the benefit of any reduced preparation costs will be mitigated if the acquirer measures non-controlling interest (NCI) at fair value). In the IASB’s view, the new requirements will not cause preparers to change their accounting systems. The IASB further states that many of the changes made to IFRS 3 and IAS 27 are designed to address areas for which practice is divergent, principally because IFRS does not deal with the issue. The IASB’s assessment is that these changes will reduce preparation costs by providing preparers with clearer principles and added guidance in some areas of accounting for business combinations and subsequent accounting; and

(b) for users, some of the changes made to the existing standards have been made to address divergent practice and provide clarification on some areas of acquisition accounting, so the clarifications will improve the comparability of the information provided on business combinations. Furthermore, the new requirements will lead to significant improvements between IFRS and US GAAP.

3.2. EFRAG consultation process

After the final publication of the standards in January 2008 the European Commission asked EFRAG to develop a recommendation regarding endorsement and provide an effect study report based on the work already done by IASB.

Regarding potential effects of endorsement, EFRAG started its assessment by reviewing IFRS 3R, IAS 27A and the effects study work carried out by the IASB. Based on these discussions, EFRAG reached an initial assessment as to the costs and benefits likely to arise from the implementation of the two standards in the EU. In carrying out this assessment, EFRAG focused primarily on the main changes introduced by IFRS 3R and IAS 27A. They are discussed separately in the main sections of this report.

8

At the same time, EFRAG decided to carry out some additional, targeted consultations with preparers and users. With that in mind, it prepared two questionnaires which is used as the basis for discussions with a number of companies and users (’the private consultations’). EFRAG also consulted on various aspects of the new standards with its User Panel.

EFRAG’s overall assessment is that on balance, the benefits that are expected to arise from the implementation of IFRS 3R and IAS 27A in the EU will exceed the costs expected to be incurred.

Regarding the endorsement advice itself, EFRAG has carried out an evaluation of IFRS 3R and IAS 27A. As part of that process, EFRAG issued a draft advice for public comment and, when finalising its advice and the content of this letter, it took the comments received in response into account.

EFRAG supports IFRS 3R and IAS 27A and has concluded that it meets the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards.

EFRAG recommends the adoption of IFRS 3R and IAS 27A for use in the EU.

EFRAG’s overall assessment is that on balance, the benefits that are expected to arise from the implementation of IFRS 3R and IAS 27A in the EU will exceed the costs expected to be incurred.

4. EFFECT ANALYSIS

4.1. Methodology

The report aims at analysing the potential effects of introducing IFRS 3R and IAS 27A in the EU. The analysis of these potential effects was prepared by the Commission services using the following sources of input in preparing the report:

• Results and comment letters from the earlier consultations by the IASB and EFRAG on the Exposure Draft and on the Endorsement Advice.

• Effect study reports issued by EFRAG (ANNEX 1) and the IASB (ANNEX 4)

• Academic research and reports by organisations or associations.

• Interviews and meetings with EFRAG staff and EFRAG User Panel.

9

4.2. Analysis of main issues in IFRS 3R

4.2.1. Contingent considerations

IFRS 3R clarifies that an acquirer is required to account for contingent consideration separately from compensation for future services which, similar to the accounting for other future services, is recognised in profit and loss if and when incurred. As a result, preparers will henceforth need to evaluate the agreements with the selling shareholders to identify which arrangements involve additional payments comprise “genuine” contingent consideration and which involve compensation for future services. In addition, IFRS 3R requires contingent consideration to be recognised at fair value at the date of the acquisition, rather than including contingent consideration in the cost of a business combination at the acquisition date if the additional payment or refund is probable and can be measured reliably. IFRS 3R requires contingent consideration to be classified as either a liability or as equity. It also provides specific guidance on how to subsequently measure the contingent consideration, and states that after initial recognition, an obligation for contingent consideration that is classified as a liability is required to be remeasured, with changes in the fair value being recognised in profit and loss. In line with the guidance in existing IFRS, if the obligation is classified as equity, remeasurement is not required.

In its assessment of this new requirement, the IASB indicated that this change is likely to result in significantly more contingent consideration arrangements being recognised at the date of the acquisition. Such arrangements would need to be recognised at fair value and thus would involve preparers with increased preparation costs.

EFRAG’s assessment is that, while some preparers will incur additional costs as a result of these changes, some—but not all users—will benefit from the changes.

The Commission Services conclude that this requirement cannot be implemented without costs, but costs will be outweighed by additional benefits.

4.2.2. Acquisition-related costs

IFRS 3R requires all acquisition-related costs, other than costs to issue debt or equity instruments, to be recognised as expenses at the date of the acquisition, rather than included in the cost of the acquisition as is required at present.

The IASB’s assessment was that this change would have no impact on preparation costs and would have a neutral effect on users.

EFRAG’s assessment is that for preparers, there will be no significant effect on preparation costs. For users, this change will have little or no cost or benefit implications. Overall, EFRAG’s assessment is that the amendment will not have any significant cost or benefit implications.

The Commission Services conclude that this change was introduced based on conceptual reasons and will not have significant cost or benefit implications for preparers and users.

10

4.2.3. Step acquisitions

IFRS 3R removes the requirement to measure each asset and liability acquired in a step acquisition separately. Instead, goodwill is measured only once—at the date control is achieved. In addition, the difference between the carrying amount of the previously held investment and its fair value is recognised in profit and loss.

The IASB assessed the new accounting for step acquisitions to be positive for preparers, on the basis that preparation costs will be reduced significantly.

The IASB assessed that users would also benefit from this change in accounting, mainly because the change is likely to enhance comparability and usefulness of financial information, with no significant additional costs for users.

EFRAG agrees that this will reduce cost for preparation, but was less optimistic about the amount of cost savings because the change will require an additional valuation (of the previously held investment) at the time the acquirer obtains control of the acquiree, which will involve preparers with additional costs to estimate the fair value of the previously held interest. Some preparers are likely to involve valuation experts to assist them with producing the information under this amendment, thus incur additional costs.

EFRAG agrees that this change will result in increased comparability. Some users have indicated that they believe that comparability will increase significantly. The indication is also that for some users the information provided is more useful and relevant than the information in existing IFRS 3, mainly because of the way goodwill in a step acquisition is determined.

EFRAG’s assessment is that the revisions to the accounting treatment of step acquisitions will result in a cost saving for preparers and benefits (but no costs) for users.

The Commission Services conclude that this amendment will result in cost savings for preparers and an increase in benefits for users.

4.2.4. Partial acquisitions - less than 100 percent

For a business combination in which the acquirer achieves control without buying all of the equity interest in the acquiree, IFRS 3R requires the remaining equity interests (the non-controlling interests (NCI)) to be measured either at fair value or at the non-controlling interests’ proportionate share of the acquiree’s net identifiable assets. This measurement option is available on a transaction-by-transaction basis. Under existing IFRS 3, only the proportionate interest approach is permitted. In effect, IFRS 3R now permits goodwill to be recognised at a ‘grossed-up’ or at a ‘full goodwill’ value.

The IASB assessed the effect of adding this option to IFRS 3 as being neutral, mainly because it is an option: entities can choose not to change the measurement approach they use at present.

EFRAG assesses that measuring NCI at fair value at the acquisition date, compared to using the proportionate approach, will imply that:

• goodwill recognised in the consolidated financial statements will be higher; and

11

• the acquisition of all (or some) of the NCI will result in smaller reduction in the equity of the group.

EFRAG also notes that, because there is a choice to be made, preparers may incur costs in deciding which option to choose for each of the business combinations undertaken. This will be particularly so if they wish to consider the implications described above on a transaction-by-transaction basis. However, in EFRAG’s view preparers are already required to monitor individual business combinations acquired in prior years in order to address matters such as impairment of goodwill and monitor the changes, if any, to contingent consideration and deferred tax benefits associated with those business combinations. EFRAG’s assessment is that taken together these costs are unlikely to be significant.

Regarding users the IASB assessed the introduction of an option as having a negative effect, because it would reduce comparability. In the IASB’s view, a mitigating factor is that it is relatively easy for users to adjust an NCI measured at fair value so that it is measured on the proportionate method. It is however not so easy (and is more costly) to adjust an NCI measured on the proportionate method so that it is measured at fair value.

On the other hand, the IASB noted that in some cases users will benefit from having information on NCI at fair value at the date of the acquisition. The IASB’s understanding is that many analysts value the whole entity and then deduct their estimate of the fair value of the NCI to obtain the value of the parent’s share. The cost of that estimate is likely to be reduced for entities that elect to measure NCI at fair value.

Comparability of information is unlikely to be affected by the option should preparers continue to use the proportionate method to measure NCI initially. However, in EFRAG’s view the introduction of a free choice on a transaction-by-transaction basis will reduce comparability and will thus involve additional costs for users. There will be some benefits for some users in certain situations in introducing the option to fair value NCI—for other users and in other circumstances there may be little if any benefit. EFRAG’s assessment however, is that those benefits will probably not exceed the incremental cost arising from the reduction in comparability. The increase in incremental costs will vary depending on whether preparers select a consistent accounting policy or opt to use the ‘free-choice’ on how to measure NCI.

Thus it seems that these amendments will have no significant cost or benefit implications for preparers. For users, the assessment is that costs will exceed benefits. Therefore, EFRAG’s overall assessment is that the costs of this amendment exceed the benefits.

The Commission Services conclude that this measurement option may overall increase costs compared to benefits. However, the IASB and EFRAG consultation demonstrated that many EU stakeholders argued against the fair value approach and as a consequence of this the IASB introduced this option. The Commission Services therefore conclude that this option will facilitate the use of the standards in practice.

12

4.2.5. Definition of a business

The definition of a business has been amended to clarify that it can include an integrated set of activities and assets that is capable of being operated as a business; IFRS 3 refers to the elements of a business as “being conducted and managed”. Additional guidance in IFRS 3R makes it clear that “a business need not include all of the inputs or processes…if market participants are capable of acquiring the business and continuing to produce outputs, for example, by integrating the business with their own inputs and processes”.

In its Effect Analysis, the IASB did not specifically comment on the effects of the change to the definition of a business.

EFRAG had some concerns whether the language used in IFRS 3R meant that the boundary between acquisition of businesses and acquisition of assets is unclear; and this might lead to difficulties in interpreting whether a transaction involves a business as defined in IFRS 3R. This uncertainty is likely to involve some additional costs for preparers. Furthermore, some EFRAG members were concerned that the consequence of the broader definition might be that some transactions that were previously considered asset transactions in IFRS 3 might need to be accounted for as business combinations in accordance with IFRS 3R.

Although EFRAG had some concerns whether the impact for users would be increased costs, it concluded that the benefits of the enhanced comparability that will arise from the amendment will be higher.

On balance, EFRAG believes that this amendment is unlikely to involve preparers and users with any significant implications on costs and benefits.

The Commission Services conclude that this amendment will not create significant impacts regarding costs and benefits.

4.2.6. Fair value as a measurement attribute

Firstly, IFRS 3R retains the definition of fair value that is currently used in existing IFRS 3, but omits the application guidance included in B16 of IFRS 3. IFRS 3R also adds guidance to the way some assets and liabilities ought to be classified and designated at the date of the acquisition. It clarifies that an acquirer must consider the terms and conditions relating to assets and liabilities that existed on the date of the acquisition, in respect to the initial classification and designation.

Secondly, in some cases IFRS 3R requires greater use of fair value for certain aspects on accounting for business combinations. In other cases, such as the accounting for some aspects of step acquisitions, the use of fair value will be reduced.

In its Effect Analysis, the IASB states that the changes will only affect contingent consideration and step acquisitions. It further explains that whether an entity will need to make additional, or fewer, fair value measurements will depend on the circumstances of the acquisition and provides some examples to this effect. The IASB did not specifically comment on the effects that the increase in the use of fair value or the removal of application guidance on fair value would have on users.

13

EFRAG believes that the amendment will involve preparers in additional costs, mainly because preparers are likely now to spend more time researching other IFRS or other GAAPs (like US GAAP) to determine how to apply fair value to the components of the business combination, but EFRAG’s assessment is that these costs will be insignificant.

When guidance is eliminated, it is always possible that it will result in diversity of practice. EFRAG’s assessment, however, is that it is unlikely that significant diversity will arise on the issues that were addressed in the omitted. EFRAG also understands that one of the areas of particular concern to many users is the area on valuing intangibles at fair value, particularly regarding the seemingly arbitrary allocation of value between different intangible assets. This issue was not covered in the omitted guidance.

Therefore, EFRAG’s assessment is that the only impact these changes will have on preparers and users is that the cumulative effect of the increased use of fair value compared to the existing IFRS 3 could involve some preparers in additional year-one and on-going costs. However, these additional costs are unlikely to be significant.

The Commission Services conclude that the requirement will increase costs for preparers, but the increase will not be significant.

4.2.7. Scope

The scope of IFRS 3R has been extended to include business combinations involving mutual entities and cooperative entities and those combinations achieved by contract alone without obtaining an ownership interest.

In its Effect Analysis the IASB noted that for those entities that were outside of the scope of IFRS 3, the application of the acquisition method for business combinations is likely to result in a significant change in accounting, because many mutual entities and those entities entering ‘by contract alone’ have been applying the pooling of interests method. Those entities are likely to be faced with significantly higher preparation costs when they implement IFRS 3R. The IASB assessed this new requirement to have a positive effect on users, mainly because users will benefit from a reduction in the costs of monitoring different accounting and because the new requirement will result in a significant increase in comparability of financial information relating to business combinations involving mutual entities.

EFRAG agrees that, depending on what accounting has been used in the past to account for business combinations, this change could involve some preparers in significant changes in practice and, as a result, could involve significant implementation costs. However, EFRAG is of the view that the majority of entities would not be affected.

EFRAG’s assessment is that the incremental costs for users are likely to be insignificant and in any case users are likely to obtain some benefits from the new requirement.

Therefore, this new requirement seems likely to involve some preparers in significant implementation costs, although the majority of companies are unlikely to be affected. On the other hand, for users the incremental costs are likely to be insignificant. Users will though benefit from increased comparability and better quality information. Overall, EFRAG’s assessment is that these benefits are likely to exceed the costs.

14

The Commission Services conclude that, although some preparers may face significant costs in order to comply with the requirements, the users will benefit from that.

4.3. Analysis of main issues in IAS 27A

4.3.1. Changes in ownership interest that do not result in control of another entity being lost

IAS 27A requires preparers to account for transactions with NCI involving acquisitions and disposals of interest in a subsidiary entity without loss of control as equity transactions. No further goodwill will be recognised when a NCI is purchased. Neither will goodwill be derecognised when a NCI is disposed of, and control is not lost.

The IASB assessed that preparation costs would be reduced for such transactions, because the absence of guidance in existing IFRS resulted in some preparers having incurred costs by obtaining professional advice on how to account for these transactions.

EFRAG agrees that the amendment is likely to mean some preparers will need less professional advice. EFRAG’s also believes that, depending on the accounting treatment currently being adopted by preparers, the cost of calculating the information needed to comply with the amendment will in most cases be low, relative to the alternative methods, as it does not require any fair value measurements of assets and liabilities. EFRAG’s assessment is that for most preparers these cost savings will probably not be significant.

EFRAG has also considered whether the amendment will benefit users of financial statements and/or whether the amendment will in some way increase the burden on users and believes that the comparability that will result from having a single method of accounting for such transactions will be significant.

Overall, EFRAG’s assessment is that this amendment will impose no significant additional costs on preparers or users, but is likely to result in significant additional benefits for users.

The Commission Services conclude that this amendment will increase the benefits for users without increasing costs significantly.

4.3.2. Changes in ownership interest that result in control of another entity

being lost

This amendment requires that, when a parent entity loses control of a subsidiary, it should remeasure at fair value any retained ownership interest in the former subsidiary and recognise any resulting profit or loss in the income statement. Existing IAS 27 is silent on the subject.

15

The IASB assessed the costs involved in this amendment to be relatively low, and concluded that the effect for preparers would be neutral. The IASB also thought providing guidance on how to measure a gain or loss on disposal should reduce audit costs and the costs of seeking professional advice, and therefore benefit preparers. The IASB assessed the affect on users to be positive.

EFRAG agrees with the IASB’s assessment and reasoning. EFRAG understands that some preparers generally fair value the entire interest, when undertaking a transaction to dispose of the controlling interest in an entity. For some of these preparers obtaining the fair value of the retained investment, might not pose additional effort (or costs). However, for those entities that do not have the information on fair value of the retained investment, obtaining that valuation will involve additional costs for preparers. For example, some preparers might need to consider changes to their accounting systems and the level of valuation expertise required to estimate the fair values of the ownership interests that are retained in a previously held subsidiary when control in that subsidiary is lost.

Regarding the effects for users EFRAG agrees that the accounting for loss of control of a subsidiary and the remeasurement of the retained investment will be comparable as all entities will be measuring the gain or loss on disposal on a consistent basis. EFRAG’s assessment is that, because of the enhanced comparability, some benefit for users will arise from this amendment. However, the view of the majority of EFRAG members is that the accounting that IAS 27A requires is not the most appropriate of the alternatives available and this largely offset the benefits to users of having information that is more comparable.

EFRAG agrees that the amendment will not have significant incremental cost implications for preparers. Neither will the amendment involve users in significant incremental costs, because users can easily adjust out of earnings the gain resulting from the remeasurement of the retained interest if their analysis requires adjustments for such non-recurring items.

However, EFRAG believes that the amendment will result in only limited benefits to users mainly because, as explained above, the benefits of comparability are compromised by accounting that EFRAG believes is inappropriate.

The Commission Services conclude that the cost and benefit implications of this amendment are limited.

4.3.3. Accounting for losses attributable to NCI

Existing IAS 27 requires losses in a subsidiary that exceed the NCI to be allocated to NCI only if the NCI owners have a binding agreement to fund the losses. In the absence of such an agreement, the losses are attributable to the controlling interest only. If the subsidiary subsequently reports profits, these profits are allocated to the controlling interest until the share of losses previously absorbed by the controlling interest have been recovered. IAS 27A requires losses to be allocated between the controlling interest and NCI based on their proportionate ownership interest, even if that means the NCI becomes a negative number.

16

EFRAG’s assessment is that the amendment will be simpler to apply than the existing requirements, and is therefore likely to result in a reduction in preparation costs.

The IASB’s assessment was that this amendment would have no effect on the costs of users. EFRAG shares that view. It’s assessment is also that some users might find the information provided as a result of the amendment more useful than that provided under existing IFRS. On the other hand, for other users it might be less useful.

Overall, EFRAG’s assessment is that, although the benefits arising from this amendment are likely to exceed the costs, there are not likely to be any significant cost or benefit implications.

The Commission Services conclude that there are no significant implications of this amendment regarding cost or benefit for preparers and users.

5. OVERALL COST-BENEFIT CONSIDERATIONS

The Commission Services have considered the main costs and benefits of endorsing IFRS 3R and IAS 27A. The Commission Services tentatively conclude that the benefits of the revision outweigh the costs.

The main benefits of the revision will be the following:

• Clearer principles and additional guidance integrated in the standards

• Increased transparency through additional disclosure requirements

• Increased comparability on an international level

The main costs of the revision will be the following:

• Additional costs for preparation due to change of concepts in certain areas, e.g. for partial acquisitions,

• Additional costs to comply with disclosure requirements

6. COMMISSION SERVICES' CONCLUSION

The Commission Services believe that the revised IFRS 3 and amended IAS 27 meet the qualitative criteria for endorsement as defined by the IAS Regulation 1606/2002 and will have positive cost-benefits effects. They should therefore be endorsed in the EU without delay.

The Commission Services would like to express their appreciation to all stakeholders that provided valuable input to the report.

17

ABBREVIATIONS

EFRAG European Financial Reporting Advisory Group

EU European Union

EU IFRS International Financial Reporting Standards adopted by the EU

FAS/SFAS Financial Accounting Standard/Statement of Financial Accounting Standard

FASB Financial Accounting Standards Board

IAS Regulation Regulation (EC)1606/2002 of the European Parliament and of the Council of 19.7.2002 regarding the introduction of IFRS in the EU

IAS International Accounting Standard

IASB International Accounting Standards Board

IFRS International Financial Reporting Standards

M&A Mergers and Acquisitions

NCI Non-controlling interest (minority share)

SEC Securities and Exchange Commission

US GAAP United States Generally Accepted Accounting Principles

http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32002R1606:EN:NOT

ANNEX 1

EFRAG Effect study report

1

IFRS 3R Business Combinations

and

IAS 27A Consolidated and Separate Financial Statements

Effects Study Report

EFRAG’s Effects Study Report on IFRS 3R and IAS 27A

2

Contents

Pages

1 Executive summary 3 – 5

2 A brief description of how EFRAG carried out its analysis

6

3 A summary of the new standards 7 – 11

4 The IASB’s effects study material 12 - 13

5 EFRAG’s initial assessment of the costs and benefits of IFRS 3R

14 – 16

6 EFRAG’s initial assessment of the costs and benefits of IAS 27A

17 – 18

7 Stakeholders’ views on EFRAG’s initial assessments of IFRS 3R and IAS 27A

19 – 22

8 EFRAG’s final assessment of the costs and benefits of IFRS 3R

23 – 35

9 EFRAG’s final assessment of the costs and benefits of IAS 27A

36 – 39

10 EFRAG’s overall conclusions 40 - 41


3

Effects analysis on the costs and benefits of implementing IFRS 3 (Revised) Business Combinations and IAS 27 (Amended) Consolidated and Separate Financial Statements in the EU

EXECUTIVE SUMMARY

Introduction

a Following discussions between the various parties involved in the EU endorsement process, the European Commission decided in 2007 that more extensive information than hitherto needs to be gathered on the costs and benefits of all new or revised or amended Standards and Interpretations as part of the endorsement process. It has further been agreed that EFRAG will gather that information in the case of IFRS 3 (Revised) Business Combinations (IFRS 3R) and IAS 27 (Amended) Consolidated and Separate Financial Statements (IAS 27A).

b EFRAG first considered how extensive the work would need to be. For some Standards or Interpretations, it might be necessary to carry out some fair extensive work in order to understand fully the cost and benefit implications of the Standard or Interpretation being assessed. In the case of IFRS 3R and IAS 27A, EFRAG’s view was that a detailed assessment about the costs and benefits of implementing IFRS 3R and IAS 27A, was necessary. This approach is explained more fully in the section below ‘methodology’.

c EFRAG already carries out a technical assessment of all new and revised Standards and Interpretations issued by the IASB and IFRIC against the so-called endorsement criteria and provides the results of those technical assessments to the European Commission in the form of recommendations as to whether or not the Standard or Interpretation assessed should be endorsed for use in the EU. As part of those technical assessments, EFRAG gives consideration to the costs and benefits that would arise from implementing the new or revised Standard or Interpretation in the EU.

Methodology

d EFRAG started its assessment by reviewing IFRS 3R, IAS 27A and the effects study work carried out the IASB 1. Based on these discussions, EFRAG reached an initial assessment as to the costs and benefits likely to arise from the implementation of the two standards in the EU. In carrying out this assessment, EFRAG focused primarily on the main changes introduced by IFRS 3R and IAS 27A. They are discussed separately in the main sections of this report.

e EFRAG issued that initial assessment for public comment on 30 July 2008 (‘the public consultation’). It invited comment on the assessment by 19 September 2008. The comment letters received in response are available from EFRAG’s website (www.efrag.org), and a summary of them is included in this report.

f At the same time, EFRAG decided to carry out some additional, targeted consultations with preparers and users. With that in mind, it prepared two questionnaires which is used as the basis for discussions with a number of

1 A copy of the IASB’s project summary, feedback and effect analysis is annexed to this report.


4

companies and users (’the private consultations’). In some cases follow-up discussions with the consultee also took place. The individual responses received are confidential, but a summary of the information gathered is included in this report.

g EFRAG also consulted on various aspects of the new standards with its User Panel.

h EFRAG then finalised its assessment in the light of the input received on its initial assessment. Its final assessment is set out in full in the report, and is summarised in the paragraphs below.

Main findings of the Effects Study

IFRS 3R

i To summarise EFRAG reached the following conclusions on each of the amendments discussed on IFRS 3R.

• Additional disclosure—Likely to provide benefits that exceed the costs involved.

• Transition requirements—Likely to result in some increased costs for preparers and users, but those costs are not likely to be significant.

• Amendment 1: Contingent consideration—The costs and benefits will probably largely balance out.

• Amendment 2: Acquisition-related costs—The amendment is unlikely to have significant cost or benefit implications.

• Amendment 3: Step acquisitions—The amendments are likely to result in a cost saving for preparers and benefits (but no costs) for users.

• Amendment 4: Partial acquisitions – acquisitions of less than 100 percent—The costs of this amendment are likely to exceed the benefits.

• Amendment 5: Definition of a business— No significant cost or benefit implications are likely.

• Amendment 6: Fair value as a measurement attribute—No significant cost or benefit implications are likely.

• Amendment 7: Scope—No significant cost or benefit implications likely.

In addition, EFRAG’s assessment was reading and understanding the amendments would not involve any significant costs.

j EFRAG then weighed these various costs and benefits. It concluded firstly that Amendments 3 and 4 have the greatest cost and/or benefit implications involved and secondly that the net benefits arising from Amendment 3 exceed the net costs arising from Amendment 4. Therefore, EFRAG’s overall assessment is that on balance, the benefits that are expected to arise from the implementation of IFRS 3R in the EU will exceed the costs expected to be incurred.


5

IAS 27A

k To summarise, EFRAG reached the following individual final conclusions on each of the amendments discussed on IAS 27A.

• Transition requirements to IAS 27A—No significant cost or benefit implications are likely.

• Amendment 1: Changes in ownership interest that do not result in control of another entity being lost—Likely to result in no significant additional costs but significant benefits for users.

• Amendment 2: Changes in ownership interest that result in control of another entity being lost—Likely to result in only insignificant additional costs. However, it will not result in any net benefits for users.

• Amendment 3: Accounting for losses attributable to NCI—No significant cost or benefit implications are likely.

In addition, EFRAG’s assessment was reading and understanding the amendments would not involve any significant costs.

l In other words, the only amendment that is likely to have a significant effect is Amendment 1, which is expected to result in significant benefits for users. Therefore, EFRAG’s overall assessment is that the benefits that are expected to arise from implementing IAS 27A in the EU will exceed the costs expected to be incurred.


6

A BRIEF DESCRIPTION OF HOW EFRAG CARRIED OUT ITS ANALYSIS

1 EFRAG started its cost and benefit assessments by considering the work that the IASB has itself carried out on the likely costs and benefits of implementing IFRS 3R and IAS 27A. EFRAG also discussed the IASB’s Effect Analysis with EFRAG’s User Panel in order to hear its views on the IASB’s assessment of the costs and benefits to users.

2 EFRAG’s conclusion was that the IASB’s effect analysis was a good piece of work that EFRAG could, and should, build on. However, EFRAG did not agree with all the IASB’s assessments, nor did it agree with all the underlying rationale used to support those assessments.

3 (Section 3 of this report discusses the IASB’s Effect Study material.)

4 EFRAG then developed a detailed methodology that was designed to build on the IASB’s work. In particular, EFRAG decided that it needed:

(a) to carry out its own detailed initial assessment of the likely costs and benefits of implementing the new standards and consult publicly with all stakeholders on the results of its initial assessments,

(b) to consult directly with a limited number of preparers who would be affected by the amendments,

(c) to consult with a limited number of users of financial statements; and

(d) to finalise its assessment in the light of all the input received.

5 EFRAG included the results of its initial assessment in an Invitation to Comment, which it issued for public comment on 30 July 2008 and invited public comment by 19 September 2008. At the same time that EFRAG issued its Invitation to Comment, the work described in (b) and (c) started.

6 The input from EFRAG’s various consultations with stakeholders is summarised in the respective sections of this report.

7 In October EFRAG finalised its assessment in the light of the input received. This report is the result.


7

A SUMMARY OF THE NEW STANDARDS

IFRS 3 (Revised) Business Combinations

8 A business combination occurs when one entity (‘the acquirer’) is deemed to have acquired control of another (‘the acquiree’). IFRS 3R explains how that acquisition should be accounted for in the financial statements of the acquirer.

9 There are three ways in which the acquirer can obtain control of the acquiree.

(a) The most common way involves the acquirer acquiring the whole of the acquiree in a single transaction. This is a one-step 100% acquisition.

(b) The acquirer acquires control of the acquire by first acquiring an interest that is not a controlling interest and then, in one or more further steps, by increasing that holding until it is a controlling interest. This is often referred to as a step acquisition.

(c) The acquirer acquires control (either in one step or in more than one step) of the acquiree but does not acquire 100% of the acquiree. This is often referred to as a partial acquisition.

One-step 100% acquisition

10 Put simply, under existing IFRS 3 a one-step 100% acquisition is accounted for by:

(a) bringing onto the consolidated balance sheet all the assets and liabilities of the acquiree (other than goodwill) at the amount it is estimated the acquirer paid for them (in other words, at their acquisition date fair value);

(b) recognising the cost of the acquisition (for example, by reducing cash balances if cash consideration is paid and by increasing equity if equity shares are used); and

(c) recognising the difference between the cost calculated in (b) and the aggregate fair value calculated in (a) as goodwill.

Thus, to take a simple example:

Assume Company A buys 100% of Company B for €6m of cash and €4m of equity shares. At that date, Company A estimates that the fair value of Company B’s total net assets (other than goodwill arising on acquisition) is €8m. Under existing IFRS 3, Company A will recognise on its consolidated balance sheet the acquiree’s net assets of €8m plus goodwill arising on acquisition (henceforth ’goodwill’) of €2m. It will also reduce its cash balances by €6m and recognise an increase in equity of €4m.

11 IFRS 3R makes two changes to this accounting. They relate to the treatment of contingent consideration and to the treatment of acquisition-related costs. (Both these changes also apply to the accounting for step acquisitions and partial acquisitions, which are discussed later in this appendix.)


8

Contingent consideration

12 Sometimes part of the consideration paid by the acquirer is contingent on the occurrence of a future event(s). This is also referred as contingent consideration and can comprise a liability or an equity component.

13 Under existing IFRS 3 contingent consideration is recognised only at the date of acquisition if its payment is probable and it can be measured reliably. Subsequently, if it becomes probable that contingent consideration not so far recognised will be payable and it can by then be measured reliably, it is recognised at that point and adjusted against goodwill.

14 Under IFRS 3R, the acquisition date fair value of any contingent consideration is recognised immediately (and taken into account in calculating the amount of goodwill etc). If that fair value subsequently changes, it will have no impact on the amounts at which goodwill and the other assets and liabilities acquired via the business combination are accounted for.

Acquisition-related costs

15 An acquirer often incurs acquisition-related costs such as costs for the services of valuation experts, legal fees, banking fees and other acquisition-related third party costs, when it undertakes a business combination.

16 Currently acquisition-related costs are included in the cost of the investment (ie in the €10m in our example above), and are therefore taken into account in calculating the value attributed to goodwill. Under IFRS 3R, such costs will be expensed immediately. As was the case with IFRS 3, the costs to issue debt or equity securities will under IFRS 3R be recognised in accordance with IAS 32 and IAS 39.

Step acquisitions

17 Under existing IFRS 3, a step acquisition is accounted for by:

(a) accounting for all the assets and liabilities of the acquiree (other than goodwill) in exactly the same way as for a one-step acquisition (see paragraph 3(a) above). The difference that arises when these identifiable net assets are revalued at the date of the acquisition is recognised in equity;

(b) by adding together the cost of each of the steps to arrive at the aggregate cost of the acquisition; and

(c) determining the goodwill separately on each step and then aggregating it.

Thus, to take a simple example:

Assume Company A acquired a 30% investment in Company B in June 2007 for €2.7m, which included an amount of €0.15m relating to goodwill. The net assets in Company B on that date amounted to €8.5m. In June 2008 Company A acquires the remaining 70% of Company B for €8m in cash. At that date, Company A estimates that the fair value of Company B’s total net assets (other than goodwill arising on acquisition) is €9.5m. Under existing IFRS 3, Company A will recognise on its consolidated balance sheet the acquiree’s net assets of €9.5m on the date of the acquisition. It reduces its cash balances by €8m, and records goodwill for a total amount of €1.5m calculated in two steps as follows:

• Step 1: Goodwill arising on 30% acquisition: based on the acquisition date: €0.15m


9

• Step 2: Goodwill arising on 70% acquisition: €8 less €6.65m (€9.5m x 70%) : €1.35m

Furthermore, Company A will derecognise its investment in Company B with a carrying amount of €2.7m (assuming no post acquisition profits) and will recognise a revaluation reserve (in equity) arising on the previously held investment of € 0.3m being the increase in the fair value of the net assets in Company B from Company A’s previously acquired interest ((€9.5m-€8.5)X30%)).

18 Under IFRS 3R, the accounting treatment of the identifiable net assets of the acquiree (ie the assets and liabilities of the acquiree other than goodwill) is the same. However:

(a) the fair value of the acquirer’s interest in the acquiree immediately prior to the moment control is acquired is calculated and treated as part of the consideration given to acquire the controlling interest. The difference between the fair value of the previously held investment in the acquiree and its carrying amount is recognised in profit or loss.

(b) goodwill is calculated only once—at the date control is achieved—rather than on each step. The amount of goodwill recognised is the difference between consideration given to acquire control (ie the aggregate of the fair value of any previously held investment in the acquiree and the consideration transferred) and the fair value of the identifiable net assets acquired.

Thus to illustrate IFRS 3R, using the example above:

Company A would record net assets of €9.5m and reduce its cash balances by €8m. The fair value of its previously held interest is determined to be €2.75 (after taking into account the effects of the control premium included in the total price paid for the controlling interest). Goodwill would be calculated at the date control is obtained and amounts to €1.25: ((€8+€2.75m) less €9.5). In addition, the difference between the carrying amount of the previously held investment of €2.7 and its fair value (€2.75) of €0.05m is recognised in profit and loss rather than in equity.

Partial acquisitions

19 Under existing IFRS 3, the accounting is as described above except that, because 100% of the identifiable net assets of the acquire are recognised, it is necessary to complete the double-entry by recognising the minority shareholders’ (henceforth Non-controlling Interest (or NCI) holders’) interest in those net assets.

20 IFRS 3R permits entities to continue to measure NCI in accordance with the existing IFRS 3. However, it also permits entities to measure NCI at its fair value at the date control is acquired. This is a free choice that can be applied business combination-by-business combination.

21 One effect of exercising this option is that the difference between the fair value of the NCI and the amount at which it is measured under existing IFRS 3 (at its proportionate interest of the fair value of the acquiree’s identifiable net assets) would usually increase the amount at which goodwill is measured. This is sometimes referred to as the ‘full goodwill’ method, as it includes the amount of goodwill that arises from the parent’s share in the consolidated group as well as the share held by the NCI.


10

Amendments to IAS 27 Consolidated and Separate Financial Statements

22 When a parent-subsidiary relationship exists between two entities, the parent entity is required to prepare a set of financial statements that account for the assets and liabilities of all the members of the group as if the group is a single entity (the consolidated financial statements). IAS 27 sets out how those consolidated financial statements should be prepared.

23 The main purpose of the amendments to IAS 27 is to address the accounting for transactions that involve the non-controlling interest (the NCI) of a group entity. Specifically, the Amendments address the way the following transactions involving NCI are accounted for in the consolidated financial statements:

(a) changes in ownership interest that result in control of another entity being neither gained nor lost;

(b) disposals of interests that result in a loss of control of the acquiree; and

(c) accounting for losses attributable to NCI.

24 Other than the changes in paragraph 28, the amendments to IAS 27 do not change the other requirements in IAS 27.

Changes in ownership interest that do not result in control of another entity being lost

25 After a parent has acquired control of a subsidiary but not a 100% interest, it might decide to buy some (or all) of the remaining interest (ie the NCI). Alternatively, regardless of whether it holds a 100% interest or a smaller but controlling interest, it might decide to sell some of its interest, whist keeping control of that subsidiary.

26 Existing IAS 27 does not specify how such transactions should be accounted for and, as a result, a variety of methods are being used. Under IAS 27A, such transactions are treated as transactions between equity holders (on the one hand the controlling equity holder and on the other the holder of the NCI) in their role as equity holders. This means that any ‘gains’ or ‘losses’ arising on such transactions are treated as movements between components of equity and are not recognised in the income statement. Neither does the parent entity recognise or derecognise any net assets in the consolidated balance sheet as a result of such transactions.

Changes in ownership interest that do result in control of another entity being lost

27 A parent may also decide to dispose of some or all of its interest in a subsidiary and, by doing so, to give up its control of that entity.

28 Existing IAS 27 requires the retained interest in the former subsidiary to be measured at its carrying amount prior to the disposal. Any gain or loss on the part of the interest that has been disposed of is recognised in the income statement.

29 IAS 27A requires the parent to remeasure any retained interest at fair value at the date control is lost. Any difference between the carrying amount of the retained investment immediately prior to losing control and its fair value is recognised in profit or loss, along with any gain or loss on the interest disposed of.


11

Accounting for losses attributable to NCI

30 When the parent has a less than 100% interest in a subsidiary and that subsidiary incurs losses, the losses need to be allocated between the controlling interest and the non-controlling interest.

31 Existing IAS 27 requires the losses to be allocated proportionately between the controlling interest and the non-controlling interest, except that:

(a) losses in a subsidiary that exceed the NCI interest are to be allocated to NCI only if the NCI have a binding agreement to fund the losses. In the absence of such an agreement, the losses are allocated to the controlling interest only; and

(b) if the subsidiary subsequently reports profits, these profits are allocated to the controlling interest until the share of losses previously absorbed by the controlling interest have been recovered.

32 Under IAS 27A, losses are allocated between the parent and NCI in proportion to their ownership interests, even if this results in NCI having a balance that is negative.


12

THE IASB’s EFFECT STUDY MATERIAL

33 When the IASB issued IFRS 3R and IAS 27A, it also issued a publication entitled Business Combinations II: Project summary, feedback and effect analysis. The Effects Analysis part of the publication contains an assessment by the IASB of the costs likely to be incurred by preparers to implement the new requirements and by users of financial statements in using the information.

34 In the material, the IASB explains the process and the rationale underlying its assessments. The IASB also makes it clear that:

(a) the evaluations of costs and benefits are necessarily qualitative, rather than quantitative, given the inherent difficulties of quantification;

(b) the focus has been put on assessing the likely costs and benefits of the new requirements relative to the requirements they are replacing (i.e. focusing on whether the relative effect is positive, negative or neutral);

(c) the assessments look only at the likely effects on preparers and users, but not other parties, notably auditors;

(d) the assessments are based on the likely effect of the new requirements. The actual effects will not be known until the new requirements have been applied; and

(e) the assessments of the effect on the financial statements are descriptive rather than judgemental. The IASB makes clear that it cannot assess how a change in the disclosure or measurement requirements will affect individual entities.

35 The IASB further explains that its effect analyses also considered:

(a) the comparative advantage that preparers have in developing information, when compared to the costs that users would incur to develop surrogate information;

(b) the benefit of better economic-decision making as a result of improved financial reporting; and

(c) that there will also be economic effects, and, while these effects are expected to be beneficial to some entities, they are likely to be detrimental to others.

36 Overall, the IASB’s assessment of the changes in the new standards is that:

(a) for preparers, preparation costs will be reduced, as preparers will be provided with clearer principles to follow. This will be the case regardless of whether the acquisition is a one-step 100 per cent acquisition or a partial or a step acquisition (although in a partial acquisition, the benefit of any reduced preparation costs will be mitigated if the acquirer measures NCI at fair value). In the IASB’s view, the new requirements will not cause preparers to change their accounting systems. The IASB further states that many of the changes made to IFRS 3 and IAS 27 are designed to address areas for which practice is divergent, principally because IFRS does not deal with the issue. The IASB’s assessment is that these changes will reduce preparation costs by


13

providing preparers with clearer principles and added guidance in some areas of accounting for business combinations and subsequent accounting; and

(b) for users, some of the changes made to the existing standards have been made to address divergent practice and provide clarification on some areas of acquisition accounting, so the clarifications will improve the comparability of the information provided on business combinations. Furthermore, the new requirements will lead to significant improvements between IFRS and US.


14

EFRAG’S INITIAL ASSESSMENT OF THE COSTS AND BENEFITS OF IFRS 3R

Introduction

37 EFRAG considered whether, and if so to what extent, implementing IFRS 3R in the EU might involve preparers and users incurring year-one costs and incremental on-going costs, and whether those costs combined are likely to exceed the benefits to preparers and users of financial statements.

38 EFRAG considered the effects of all the changes made in IFRS 3R, compared to the existing IFRS 3. EFRAG also considered the consequences the revisions to IFRS 3 would have on other IFRSs and the amendments thereto.

39 In carried out this initial assessment, EFRAG recognised that it was likely that the level of the overall implementation costs and overall benefits of the new standards would vary and was likely to depend on factors such as:

(a) the terms and conditions of the business combination agreement;

(b) whether the parent acquires control in a one-step 100 percent acquisition of the acquiree or whether control was acquired in two or more steps;

(c) whether the acquisition is for less than 100 percent interest in the acquiree; and

(d) the level of in-house expertise available to assist with implementing the new requirements in year one and thereafter.

EFRAG tried to bear this in mind in its assessment.

40 As previously explained, EFRAG started its assessment by reviewing the effects study material that the IASB had prepared a. EFRAG’s conclusion was that the IASB’s effects analysis was a good piece of work that EFRAG could, and should, build on. However, EFRAG did not agree with all the IASB’s assessments, nor did it agree with all the underlying rationale used to support some of those assessments.

41 EFRAG discussed the potential costs and benefits of implementing IFRS 3R at various EFRAG meetings up to and including the July 2008 meeting.

42 EFRAG based its initial assessment on the changes or amendments that it believed likely to be of most relevance to an assessment of the costs and benefits of implementing IFRS 3R. The main areas affected by those changes are:

(a) contingent consideration (Amendment 1);

(b) acquisition-related costs (Amendment 2);

(c) step acquisitions (ie where the acquirer needs more than one transaction to acquire a controlling interest) (Amendment 3);

(d) partial acquisitions (ie where less than 100 per cent of the acquiree is acquired) (Amendment 4);

(e) the definition of a business (Amendment 5);


15

(f) fair value as a measurement attribute (Amendment 6); and

(g) scope (Amendment 7).

Before considering those amendments, EFRAG has first carried out an initial assessment of the following more general aspects of implementing IFRS 3R:

(h) reading and understanding the revised requirements;

(i) additional disclosure requirements; and

(j) transitional requirements.

Summary of EFRAG’s initial cost and benefit considerations on IFRS 3R

43 On the basis of its initial assessment, EFRAG tentatively reached the following individual initial conclusions on each of the amendments discussed in IFRS 3R.

(a) Reading and understanding the amendments—No significant cost or benefit implications are likely.

(b) Additional disclosure—Likely to provide benefits that exceed the costs involved.

(c) Transition requirements—Likely to result in some increased costs for preparers and users, but those costs are not likely to be significant.

(d) Amendment 1: Contingent consideration—While some preparers will incur additional costs as a result of this amendment, some – but not all users – will benefit from the changes. Overall, the costs and benefits will probably largely balance out.

(e) Amendment 2: Acquisition-related costs— For preparers, there will be no significant effect on preparation costs. For users, this amendment will have little or no cost implications. Overall, the amendment is unlikely to have significant cost or benefit implications.

(f) Amendment 3: Step acquisitions—The amendment is likely to result in a cost saving for preparers and benefits (but no costs) for users.

(g) Amendment 4: Partial acquisitions – acquisitions of less than 100 percent—This amendment will have no significant cost or benefit implications for preparers. For users, the initial assessment is that costs will exceed benefits. Overall, the amendment the initial assessment is that the costs of this amendment are likely to exceed the benefits.

(h) Amendment 5: Definition of a business—EFRAG did not reach an overall tentative conclusion reached when it published its initial assessment for public comment.

(i) Amendment 6: Fair value as a measurement attribute—The only impact these changes will have on preparers and users is that the cumulative effect of the increased use of fair value compared to the existing IFRS 3 could involve some preparers in additional year-one and on-going costs. However,


16

these additional costs are unlikely to be significant. Overall, the initial assessment is that no significant cost or benefit implications are likely.

(j) Amendment 7: Scope—This amendment seems likely to involve some preparers in significant implementation costs, although the majority of companies are unlikely to be affected. For users, the incremental costs are likely to be insignificant. Users will though benefit from the increased comparability and better quality information. Overall, the benefits are likely to exceed the costs.

44 EFRAG tentatively concluded that Amendments 3, 4 and 5 were the main factors listed above that EFRAG needs to weigh in reaching its overall assessment of the revised standard. EFRAG believes that the net benefits arising from Amendment 3 exceed the net costs arising from Amendment 4. As previously explained, EFRAG had not yet reached a conclusion on Amendment 5, when it finalised its initial assessment.

45 EFRAG also thought that it needed to bear in mind that a key objective of revising the existing IFRS 3 was to ensure that the accounting for business combinations is the same whether an entity is applying IFRS or US GAAP. The accounting requirements in IFRS and US GAAP will now be substantially the same, with one key difference: the initial measurement of non-controlling interests. A range of other differences also remain, due to existing differences between other IFRSs and US GAAP. Nevertheless, the fact that IFRS and US GAAP will now be substantially the same will result in benefits for some users.

46 Therefore, EFRAG’s overall initial assessment was that, on balance—and subject to EFRAG’s final conclusion on Amendment 5—the benefits that are expected to arise from the implementation of IFRS 3R in the EU will exceed the costs expected to be incurred.


17

EFRAG’S INITIAL ASSESSMENT OF THE COSTS AND BENEFITS OF IAS 27A

Introduction

47 EFRAG has also considered whether, and if so to what extent, implementing IAS 27A in the EU might involve preparers and users incurring year-one costs and incremental on-going costs, and whether those costs in aggregate are likely to be exceeded by the benefits to be derived from implementing the Amendments in the EU.

48 EFRAG considered the effects of all the changes made to IAS 27A, compared to the existing IAS 27. EFRAG also considered the effects the changes to IAS 27 had on the consequential amendments to other IFRSs.

49 EFRAG based its initial assessment on the changes or amendments that it believed likely to be of most relevance to an assessment of the costs and benefits of implementing IAS 27A.

50 These main changes are:

(a) changes in ownership interest that do not result in control of another entity being lost (Amendment 1);

(b) changes in ownership interest that result in control of another entity being lost (Amendment 2); and

(c) accounting for losses attributable to non-controlling interest (NCI) (Amendment 3).

However, EFRAG started by carrying out an initial assessment of the following general aspects of implementing IAS 27A:

(d) reading and understanding the revised requirements; and

(e) transitional requirements.

Summary of EFRAG’s initial cost and benefit considerations on IAS 27A

51 The individual initial conclusions reached by EFRAG on the above main amendments to IAS 27A are:

(a) Reading and understanding the Amendments—No significant cost or benefit implications are likely.

(b) Transition requirements to IAS 27A— No significant cost or benefit implications are likely.

(c) Amendment 1: Changes in ownership interest that do not result in control of another entity being lost—This amendment will impose no significant additional costs on preparers or users, but is likely to result in significant benefits for users.

(d) Amendment 2: Changes in ownership interest that result in control of another entity being lost —This amendment will not have significant incremental cost


18

implications for preparers. Neither will the amendment involve users in significant incremental costs, because users can easily adjust out of earnings the gain resulting from the remeasurement of the retained interest if their analysis requires adjustments for such non-recurring items. However, the amendment will not result in any benefits to users mainly because the benefits of comparability are compromised by accounting that EFRAG believes is inappropriate. Overall, the amendment is likely to result in only insignificant additional costs. However, it will not result in any net benefits for users.

(e) Amendment 3: Accounting for losses attributable to NCI—The benefits arising from this amendment are likely to exceed the costs. However, overall no significant cost or benefit implications are likely.

52 In other words, the only Amendment that is likely to have a significant effect is Amendment 1, which is expected to result in significant benefits for users.

53 Therefore, EFRAG’s overall initial assessment is that the benefits (that are expected to arise from implementing IAS 27A in the EU will exceed the costs expected to be incurred to implement IAS 27A.


19

STAKEHOLDERS VIEWS ON EFRAG’S INITIAL ASSESSMENT OF IFRS 3R AND IAS 27A

Public consultation on EFRAG’s Invitation to Comment on costs and benefits

54 EFRAG published its initial assessment of the costs and benefits of implementing IFRS 3R and IAS 27A in the EU and supporting analysis (the Invitation to Comment) on 30 July 2008. It invited comments on the material by 19 September 2008.

55 The responses received can be summarised as follows:

(a) All but one of those commenting on EFRAG’s assessment of costs and benefits agreed with EFRAG’s assessment of the costs and benefits involved for users and preparers in implementing the two new standards in the EU. Those respondents also agreed with EFRAG that the benefits to be derived from the application of the new standards was likely to exceed the costs involved.

(b) One respondent did not fully agree with EFRAG’s initial assessment on the costs and benefits. In particular, this respondent disagreed with EFRAG’s initial conclusions on Amendment 3 – step acquisitions, mainly because it believes that fair valuing the pre-existing investment in a step acquisition does not produce information that is useful to users of financial statements. It also thought that in any case users were likely to adjust the figures and incur costs to do this. As a result, this respondent thinks that the overall cost savings for preparers associated with the easier accounting for step acquisitions would depend on the circumstances of each transaction.

Direct, private consultation with preparer-companies

Introduction

56 EFRAG consulted directly with a selected number of preparers, and requested their input by mid August 2008.

57 The consultation was done via a questionnaire that asked preparer-companies about the effects of the main changes made to existing IFRSs. In addition, companies were asked for input on the likely effects of the changes to IFRS 3R on the accounting for the “classification, designation, recognition and measurement of identifiable assets and liabilities acquired”. Companies were asked for input on the combined effect of implementing ‘IFRS 3R and IAS 27A as a single package’.

58 The questions put forward to preparer-companies focused mainly on the likely costs and benefits relative to the requirements they are replacing. This approach is similar to the one used by the IASB when it carried out its cost-benefit assessment, and similar to the approach EFRAG followed in its own initial assessment analysis.

59 EFRAG received feedback from 20 companies based in Germany, France, the United Kingdom, Denmark, Poland, Belgium and Italy that operate in various industry sectors, including telecommunications, technology, banking, energy, food & beverages and pharmaceuticals. For reasons of confidentially, the names of the companies cannot be disclosed.


20

60 All 20 companies completed a questionnaire, which they submitted to EFRAG. In some cases, EFRAG staff held direct face-to-face interviews with the preparer-companies, and in other cases, the companies completed the questionnaire themselves and forwarded it to EFRAG staff. In some of the latter cases, a follow-up discussion by email or conference call took place to clarify certain aspects of the questions asked.

Summary of input

61 In the main, the input provided by the direct consultation with preparers was generally consistent with EFRAG’s initial assessment of the costs and benefits for preparers. However, on some issues the consultation provided additional insights on matters for which EFRAG had not reached a conclusive decision; and, on other matters, the findings brought to light new observations on the likely effects on preparers.

62 The input provided by preparers on the overall effect of implementing the new standards can be summarised as follows:

(a) Approximately half indicated that the new standards are unlikely to have major net cost effects. These companies seemed to place greater weight on the beneficial effects of the simplifications provided in the new standards; compared to the potential increase in costs associated with the likely increase in valuation work required by some of the new requirements.

(b) A small minority noted that they were unable to comment on the overall cost-benefit impact without further analysis.

(c) The remaining participants in this part of the consultation observed that they did not expect the costs associated with the new standards to be lower than under the existing standards. However, the indication was that the overall likely increase in preparation costs would not be significant.

(d) Overall, preparers identified the following amendments to IFRS 3R and IAS 27A as likely to result in some additional costs:

(i) The increase in the use of fair value to account for transactions involving contingent consideration, step acquisitions and loss of control in subsidiaries will involve the companies with more costs. More use of fair value will increase the need for external valuation advice and is likely to increase the level of scrutiny of fair values by auditors, both externally and in-house. A further challenge is how to determine the control premium arising in a partial acquisition, which needs to be excluded from the fair valuing of the pre-existing investment. A similar concern was noted with regards to the accounting for the retained investment on loss of control of a subsidiary.

(ii) The increase in complexity associated with the requirement to re-assess assets and liabilities acquired in a business combination, in particular contractual arrangements and derivative instruments. This will involve an increase in in-house man-hours, and potentially increase the involvement of external valuation professionals. The extent of the work is likely to depend on what information can be obtained from the acquiree company. The costs involved can therefore vary.


21

(iii) The accounting for the replacement of share-based payment awards (pertaining to the acquired company) appears more complex and requires a higher level of precision than under IFRS 3. The accounting is likely to result in an increase in complexity in the valuation process.

(iv) The change to the definition of a business may result in more transactions being accounted for as business combinations.

63 Of the above overall concerns expressed by companies, (d)(i) was the most widely noted. These observations are in line with EFRAG’s initial assessment. Some companies mentioned the difficulty involved in determining some of the fair values. However, it is not always clear from the responses whether ‘being difficult’ to do also means being costly to do. This is because some of the companies noted that they are likely to use in-house valuation expertise, rather than the more costly external advice.

64 The concerns in (ii) and (iii) were expressed by only a few companies. Regarding (ii), companies expressed different views. While some companies expressed concern with the potential additional (and sometimes significant) costs, other companies indicated that clear guidance in IFRS 3R was helpful. EFRAG noted that some companies might be faced with additional costs. This was particularly so for business combinations that involve a variety of contracts including derivative contracts, in which case companies would need to undertake a reassessment exercise of the various contracts acquired. On the other hand, this sort of analysis required under IFRS 3R is generally performed during the due diligence process. For this reason, EFRAG saw no reason to consider this change a significant one. EFRAG also believes that on balance this change to IFRS 3 is unlikely to have significant cost/benefit implications to preparers and users, and for this reason as not discussed this amendment in detail in this report.

65 Finally, (iv) was considered the least problematic, with only one company specifically mentioning this area of accounting as a significant cost concern.

66 In relation to the effects on systems and processes, the overall indication is that there appears to be very little modification required to systems and processes to implement the new requirements. Preparers generally said that the existing systems used by their company’s would provide the information required under the new standards, or if changes were required, they would be only ‘minor enhancements’.

67 A few preparers specifically noted (either in the overall conclusion or in the individual questions) that the costs involved with implementing the new requirements were likely to be compensated by the benefits of having clearer and simpler requirements in the new standards. Clear accounting principles were noted on the accounting for:

(a) consideration in the form of ‘replacement’ awards

(b) step acquisitions

(c) re-assessment of assets and liabilities; and

(d) changes in interest (with no loss of control).


22

68 Half of the preparers mentioned that the accounting for step acquisitions would reduce costs. Other preparers mentioned that they would be unaffected by the benefits of having simpler accounting requirements (for example step acquisition accounting) as these were areas that did not affect their business combinations.

Direct, private consultation with users

Introduction

69 As previously explained, when EFRAG discussed the initial assessment of the effects the new standards, it decided it would be necessary to carry out additional effects study work on costs and benefits of the new standards, by consulting directly with users of financial statements.

70 EFRAG staff approached various European users/user organisations and invited them to take part in this private consultation. Users were asked to complete a questionnaire and remit it to EFRAG staff.

71 EFRAG staff received feedback from 4 user/user organisations. Two users are from Germany, one from the United Kingdom and one from a Ukrainian user organisation.

72 Similar to the approach taken when addressing the cost/benefit effects of the new standards on preparers, the questions asked to users focused on the main changes to existing IFRSs and on ‘comparing’ the likely costs and benefits relative to the requirements they are replacing.

73 EFRAG also discussed aspects of the new standards and of its assessments with the EFRAG User Panel.

Summary of input

74 Overall, the input gathered from users was broadly in line with EFRAG’s initial assessment on users. Specifically:

(a) Users generally indicated that that the benefits to be achieved from having information on business combinations under IFRS 3R and IAS 27A will be higher than the benefits of information under IFRS 3 and IAS 27A.

(b) Most of the users consulted believe that the incremental costs to users associated with implementing IFRS 3R and IAS 27A are likely to be insignificant. One user said that it was unable to respond to this question.

(c) Users did not raise costs concerns on any of the main changes made to the existing standards.

75 For some of the amendments, some users indicated that the benefits to be achieved are likely to be more significant than initially assessed by EFRAG, because the information would be more relevant and more comparable. This was particularly the case in respect to the accounting for step acquisitions (under IFRS 3R) and loss of control of a subsidiary (under IAS 27A).


23

EFRAG’S FINAL ASSESSMENTS OF THE COSTS AND BENEFITS OF IMPLEMENTING IFRS 3R

76 EFRAG’s detailed final assessment of the costs and benefits of IFRS 3R and IAS 27A is presented in the sections below. In developing its final analysis EFRAG has considered:

(a) the input provided by stakeholders on the invitation to comment on its initial assessment,

(b) the information obtained directly from preparer-companies who are assessing the effects of implementing the new standards, and

(c) the discussions and direct consultations EFRAG had with users of financial statements regarding the effects to users of the changes to the new standards

77 A summary of the input provided by stakeholders on (a) – (c) has been discussed in the paragraphs above.

78 Similar to its initial assessment, EFRAG based its final assessment on the main changes or amendments that it believed likely to be of most relevance to an assessment of the costs and benefits of implementing IAS 27A.

Reading and understanding the amendments

Costs and benefits for preparers and users

79 Whenever accounting requirements change, preparers and users need to read and understand the new requirements and this will inevitably involve an incremental year-one cost. In the case of IFRS 3R:

(a) Preparers will need to assess the impact the changes will have on the consolidated financial statements in year-one and thereafter. For example, they will need to understand:

(i) the subsequent accounting and its implications for assets and liabilities recognised in a business combination that result in changes in their fair value being recognised in profit and loss; and

(ii) the implications of the transaction-by-transaction ‘free-choice’ measurement option on how to initially measure non-controlling interests (NCI) and how that choice will affect the acquisition of all (or some) of the remaining NCI.

(b) Preparers will need to understand the implications of applying the new requirements prospectively to business combinations accounted for in accordance with IFRS 3R, while applying the requirements in existing IFRS 3 to business combinations undertaken before the transition to IFRS 3R.

(c) Preparers will need to assess the impact the changes will have on the planning and the process associated with the business combinations and on communication with stakeholders and personnel from the investor-relationship department.


24

(d) Users will need to understand why the numbers in the financial statements are different and what this means when performing their analysis and comparing year-to-year figures. Users will also need to consider the effects of the changes on ratios; for example the entity’s return-on-capital might be affected because of the change in the basis of the calculation.

80 For certain types of business combinations, the implications of the changes that will result from IFRS 3R are relatively easy to understand. However, for certain other types, the changes resulting from IFRS 3R will have a significant effect on the concepts underlying the reported numbers; in these cases the learning exercise will be greater—and indeed greater than is the case for many new and revised standards and interpretations.

Conclusion

81 Nevertheless, EFRAG’s assessment overall is that there are not likely to be any significant costs involved for preparers or users in reading and understanding IFRS 3R.

Additional disclosures


82 IFRS 3R requires preparers to provide additional disclosures compared to IFRS 3, mainly to support the changes made to existing IFRS 3 and to provide users with information on the effects of those changes in year-one and thereafter.

83 Some of the additional disclosure requirements will involve an increase in year-one and on-going costs for preparers as they have to gather the required information for the first time on the date of the acquisition and thereafter. However, EFRAG’s understanding is that generally all or some of the information will be readily available within the entity and that, as a result, the incremental costs involved are likely to be insignificant. Furthermore, the additional disclosures will result in additional on-going publication costs, although in EFRAG’s view that cost is likely to also be insignificant.

84 EFRAG also considered the effects of the additional disclosure on users of financial statements. EFRAG’s view is that the disclosures are likely to provide useful explanations on the information reported on business combinations.

Conclusion

85 EFRAG’s assessment overall is that the benefits arising from these disclosure requirements are likely to exceed the insignificant costs that are likely to be involved.

Transition requirements


86 The requirements in IFRS 3R are to be applied prospectively for annual periods beginning on or after 1 July 2009. Earlier application is permitted, but only for periods beginning on or after 30 June 2007. This means that the carrying amounts of assets and liabilities that arose under business combinations prior to the application of IFRS 3R will not be adjusted. It also means that, except for the


25

accounting for deferred tax benefits of the acquire and when the combination involves mutual entities or a contract alone combination, transactions occurring before the application of IFRS 3R will continue to be accounted for under IFRS 3. For instance, changes in the amount recognised for contingent consideration will continue to be accounted for as an adjustment to goodwill.

87 Because the transition to IFRS 3R is to be done prospectively, EFRAG’s assessment is that the transition itself will not result in incremental costs to preparers. However, preparers will have to track those transactions that relate to business combinations undertaken under IFRS 3 separately from those undertaken under IFRS 3R. Preparers are already tracking which business combinations were previously accounted for under IFRS 1 (when IFRS was adopted for the first time) and which were recorded under IFRS 3, so IFRS 3R will be adding a third method of accounting for business combinations, which would also need to be tracked in order to account for business combinations post acquisition date. Maintaining systems to monitor and track such transactions will result in some incremental ongoing costs for preparers.

88 The lack of comparability arising from prospective application of IFRS 3R will also increase costs to users.

89 EFRAG’s overall assessment is that these incremental costs to preparers and users are unlikely to be significant.

Amendment 1: Contingent consideration

Costs and benefits to preparers

90 IFRS 3R clarifies that an acquirer is required to account for contingent consideration separately from compensation for future services which, similar to the accounting for other future services, is recognised in profit and loss if and when incurred. As a result, preparers will henceforth need to evaluate the agreements with the selling shareholders to identify which arrangements involve additional payments comprise “genuine” contingent consideration and which involve compensation for future services. EFRAG’s assessment is that the incremental cost involved will be insignificant.

91 In addition, IFRS 3R requires contingent consideration to be recognised at fair value at the date of the acquisition, rather than including contingent consideration in the cost of a business combination at the acquisition date if the additional payment or refund is probable and can be measured reliably. IFRS 3R requires contingent consideration to be classified as either a liability or as equity. It also provides specific guidance on how to subsequently measure the contingent consideration, and states that after initial recognition, an obligation for contingent consideration that is classified as a liability is required to be remeasured, with changes in the fair value being recognised in profit and loss. In line with the guidance in existing IFRS, if the obligation is classified as equity, remeasurement is not required.

92 In its assessment of this new requirement, IASB indicated that this change is likely to result in significantly more contingent consideration arrangements being recognised at the date of the acquisition. Such arrangements would need to be recognised at fair value and thus would involve preparers with increased preparation costs.


26

93 EFRAG believes that, as a result of this change, preparers are likely to have to:

(a) modify their accounting systems to allow for different inputs of information needed to comply with the new requirements;

(b) modify their accounting systems so that, to the extent that contingent consideration has been classified as a liability, changes in the liability will be identified and recognised in profit and loss; and

(c) engage additional valuation experts (perhaps external consultants) and seek professional advice.

94 Generally, any change to accounting is likely to be more costly to implement if implementation requires systems’ changes. As mentioned above, this change to IFRS 3 is likely to involve some form of system changes in year-one. In addition, preparers are likely to seek additional expert advice to assist them with determining an estimate of the fair value of the contingent consideration. The effects of these two changes are likely to involve preparers with additional, not insignificant, costs.

Costs and benefits for users

95 The IASB assessed the effect of this change to be positive for users. In its view:

(a) The information should be more comparable because all contingent consideration arrangements will be accounted for in the same way.

(b) Analysis costs are likely to be lower as a result of the change, mainly because of the increased disclosure requirements. It will also be easier to monitor the settlement of these arrangements.

(c) The IASB noted that users “have told us that they are concerned that acquirers will have an incentive to overstate the liability. By doing so the acquirer is able to recognise a gain associated with a reduced obligation if the combined entity does not perform as well as expected. Therefore, the users are more sceptical about whether the information will be more useful.” The IASB nevertheless concluded that the information resulting from this new requirement will be more useful because it provides a better measure of the consideration for which the acquirer is liable and also ensures that the accounting for the business combination is more complete at the acquisition date.

96 EFRAG’s assessment is that the IASB is right to point to the enhanced comparability, improved measurement of the consideration given, increased disclosures, and greater accountability. These are all likely to result in information provided on contingent consideration being more complete, understandable and easier to monitor, resulting in an improvement in the information provided and thus benefit users. For some users, this benefit might be significant.

97 On the other hand, EFRAG’s assessment is also that:

(a) the concern raised by users (and referred to in paragraph 103 (c) above) is a valid concern and could have an effect on the benefits that would otherwise arise; and


27

(b) the need to use assumptions and estimates to determine the fair value of the liability for the additional consideration might have an effect on the comparability of the information provided on contingent consideration.

98 As a result, EFRAG is not convinced that the effect on some users would always be positive. EFRAG understands that users are likely to pay special attention to the information produced on contingent consideration, particularly when the amounts are significant. The added scrutiny might involve some users with added costs. On the other hand, it will mitigate the concern in (c) above (or some of the concern).

Conclusion

99 EFRAG’s assessment is therefore that, while some preparers will incur additional costs as a result of these changes, some—but not all users—will benefit from the changes. Overall, EFRAG’s assessment is that these costs and benefits probably largely balance out.

Amendment 2: Acquisition-related costs


100 IFRS 3R requires all acquisition-related costs, other than costs to issue debt or equity instruments, to be recognised as expenses at the date of the acquisition, rather than included in the cost of the acquisition as is required at present.

101 The IASB’s assessment was that this change would have no impact on preparation costs. That was also EFRAG’s final assessment.

Costs and benefits to users

102 The IASB assessed this change to have a neutral effect on users. It explained its reasoning as follows:

“(a) users tell us that if they are using an earnings-based model to value the entity they will adjust these costs out of earnings. We are told that the marginal cost of making that adjustment is low because analysts and investors are already reviewing the financial statements and making other adjustments.

(b) there is no effect on the comparability of the information because the accounting for acquisition costs appears to be consistent.

(c) some users tell us that they prefer these costs to be recognised as an expense and disclosed. They think that this is preferable to including these costs in goodwill. Others tell us that they are indifferent because they do not pay much attention to either goodwill or acquisition costs.”

103 EFRAG understands that some users want these costs to be capitalised, and some do not; and, if the costs are expensed, generally users will adjust them out of earnings because they are one-off costs.


28

Conclusion

104 EFRAG’s assessment is that for preparers, there will be no significant effect on preparation costs. For users, this change will have little or no cost or benefit implications for users. Overall, EFRAG’s assessment is that the amendment will not have any significant cost or benefit implications.

Amendment 3: Step acquisitions


105 IFRS 3R removes the requirement to measure each asset and liability acquired in a step acquisition separately. Instead, goodwill is measured only once—at the date control is achieved. In addition, the difference between the carrying amount of the previously held investment and its fair value is recognised in profit and loss.

106 The IASB assessed the new accounting for step acquisitions to be positive for preparers, on the basis that preparation costs will be reduced significantly.

107 EFRAG agrees that this change will indeed simplify the accounting treatment of step acquisitions in the way the IASB described, and therefore reduce the costs incurred by preparers in accounting for such acquisitions.

108 On the other hand, the change will require an additional valuation (of the previously held investment) at the time the acquirer obtains control of the acquiree, which will involve preparers with additional costs to estimate the fair value of the previously held interest. The challenges faced by preparers to determine the fair value of the pre-existing investment will vary. EFRAG understands that one of the more challenging tasks that some preparers might be faced with when determining the fair value of the pre-existing investment, is determining the value for the control premium for the acquired entity, which needs to excluded from the fair value of the non-controlling investment previously held. Some preparers are likely to involve valuation experts to assist them with producing the information under this amendment, thus incur additional costs.

109 EFRAG understands that some preparers will value the entire equity interest when they achieve control of an entity. Consequently, some preparers might already determine a ‘fair’ value for the pre-existing investment under existing IFRS 3, or will be able to obtain this information without incurring undue cost and effort.

110 Furthermore, EFRAG’s understands that step acquisitions do not occur very frequently, and when they do occur the amounts involved are sometimes insignificant.

111 EFRAG’s assessment is that the accounting for step acquisitions will, on balance, result in a cost saving for preparers. Depending on how entities undertake their step acquisitions, for some preparers this cost saving is likely to be significant.


112 The IASB assessed that users would also benefit from this change in accounting, mainly because the change is likely to enhance comparability and usefulness of financial information, with no significant additional costs for users.


29

113 EFRAG agrees that this change will result in increased comparability. Some users have indicated that they believe that comparability will increase significantly. The indication is also that for some users the information provided is more useful and relevant than the information in existing IFRS 3, mainly because of the way goodwill in a step acquisition is determined.

114 However, it is also EFRAG’s understanding is that only some users think the information will be improved for other reasons too. Some users view the gain that would be recognised on the pre-existing holding as ‘theoretical’ and of little informational value. In addition, some users might be concerned with the impact the option on measuring NCI initially will have on goodwill, and thus dilute some of the potential benefits of having a more consistent way of determining goodwill in a step acquisition.

115 IFRS 3R requires the gain recognised on the previously held investment to be disclosed. In the view of some users, because of the added disclosure there would be no additional costs to carry out the adjustment to earnings. This is mainly because users already adjust out of earnings other types of one-off gains, thus the cost of adjusting this gain is likely to be marginal.

116 EFRAG’s assessment is therefore that the new requirements will bring some added benefits to most users (primarily in the form of improved comparability and increase in usefulness of information) and will involve no incremental costs for users.

Overall conclusion

117 EFRAG’s assessment is that the revisions to the accounting treatment of step acquisitions will result in a cost saving for preparers and benefits (but no costs) for users.

Amendment 4: Partial acquisitions


118 For a business combination in which the acquirer achieves control without buying all of the equity interest in the acquiree, IFRS 3R requires the remaining equity interests (the non-controlling interests (NCI)) to be measured either at fair value or at the non-controlling interests’ proportionate share of the acquiree’s net identifiable assets. This measurement option is available on a transaction-by-transaction basis. Under existing IFRS 3, only the proportionate interest approach is permitted. In effect, IFRS 3R now permits goodwill to be recognised at a ‘grossed-up’ or at a ‘full goodwill’ value.

119 The IASB assessed the effect of adding this option to IFRS 3 as being neutral, mainly because it is an option: entities can choose not to change the measurement approach they use at present.

120 Presently, entities that chose to measure NCI at the acquisition date using the proportionate interest method are required to determine the ‘full’ amount of goodwill (by grossing up the goodwill allocated to a particular cash-generating unit that is not wholly owned) when performing an impairment test on goodwill. Only one amount for goodwill needs to be determined if an entity chooses to measure NCI initially at fair value, as the goodwill is already recognised at a ‘grossed-up’ value. However, EFRAG’s assessment is that this potential increase in ongoing costs for those


30

entities that choose to continue using the proportionate method to measure NCI is not likely to be significant.

121 On the other hand, entities that elect to measure NCI at fair value are likely to incur additional valuation costs in order to estimate the fair value of NCI. In EFRAG’s view, the costs to preparers associated with measuring NCI at fair value will vary. However, in most cases EFRAG’s view is that it is unlikely that those costs will be significant because the fair value of NCI can be determined using available market information. If market information for measuring NCI is not readily available or is costly to obtain, preparers are likely to choose not to measure NCI at fair value.

122 Measuring NCI at fair value at the acquisition date, compared to using the proportionate approach, will also imply that:

(a) goodwill recognised in the consolidated financial statements will be higher; and

(b) the acquisition of all (or some) of the NCI will result in smaller reduction in the equity of the group.

123 EFRAG also notes that, because there is a choice to be made, preparers may incur costs in deciding which option to choose for each of the business combinations undertaken. This will be particularly so if they wish to consider the implications described above on a transaction-by-transaction basis. The free measurement choice might involve preparers with some increased costs if they decide not to apply a consistent accounting policy on how to measure NCI for all their business combinations. This is because preparers will be required to monitor the different measurement bases used for each business combination in case they acquire some (or all) of the NCI at a future date. This is likely to involve preparers in added costs.

124 However, in EFRAG’s view preparers are already required to monitor individual business combinations acquired in prior years in order to address matters such as impairment of goodwill and monitor the changes, if any, to contingent consideration and deferred tax benefits associated with those business combinations.

125 In EFRAG’s view, the option in IFRS 3R on how to measure NCI initially allow preparers the choice of whether they would like prefer to change their accounting policy or not, or simply use the free choice on a transaction-by-transaction basis. In other words, preparers have the opportunity to evaluate whether they want to incur additional costs. As a result EFRAG believes that preparers will ensure that the benefits to be derived from the choice they make, are greater than the associated costs. This will apply to business combinations accounted for IFRS 3R. However, it will not apply necessarily apply to those business combinations accounted for under existing IFRS 3, as IFRS 3R does not permit previous business combinations to be restated.

126 For the reasons cited above, EFRAG’s assessment is that the new requirement will involve those preparers that choose to fair value NCI at the date of the acquisition in some year-one and on-going costs. Preparers might also be faced with some costs resulting from having to decide which option is more suitable for each business combination undertaken. On the other hand, they will no longer have to determine two goodwill amounts when testing for impairment, if the cash-generating unit to which the goodwill is allocated, is not wholly owned.


31

127 EFRAG’s assessment is that taken together these costs are unlikely to be significant.


128 The IASB assessed the introduction of an option as having a negative effect on users, because it would reduce comparability. In the IASB’s view, a mitigating factor is that it is relatively easy for users to adjust an NCI measured at fair value so that it is measured on the proportionate method. It is however not so easy (and is more costly) to adjust an NCI measured on the proportionate method so that it is measured at fair value.

129 On the other hand, the IASB noted that in some cases users will benefit from having information on NCI at fair value at the date of the acquisition. The IASB’s understanding is that many analysts value the whole entity and then deduct their estimate of the fair value of the NCI to obtain the value of the parent’s share. The cost of that estimate is likely to be reduced for entities that elect to measure NCI at fair value.

130 Comparability of information is unlikely to be affected by the option should preparers continue to use the proportionate method to measure NCI initially. However, in EFRAG’s view the introduction of a free choice on a transaction-by-transaction basis will reduce comparability and will thus involve additional costs for users. There will be some benefits for some users in certain situations in introducing the option to fair value NCI—for other users and in other circumstances there may be little if any benefit. EFRAG’s assessment however, is that those benefits will probably not exceed the incremental cost arising from the reduction in comparability. The increase in incremental costs will vary depending on whether preparers select a consistent accounting policy or opt to use the ‘free-choice’ on how to measure NCI.

Conclusion

131 Thus it seems that these amendments will have no significant cost or benefit implications for preparers. For users, the assessment is that costs will exceed benefits. Therefore, EFRAG’s overall assessment is that the costs of this amendment exceed the benefits.

Amendment 5: Definition of a business

Costs and benefits for preparers

132 The definition of a business has been amended to clarify that it can include an integrated set of activities and assets that is capable of being operated as a business; IFRS 3 refers to the elements of a business as “being conducted and managed”. Additional guidance in IFRS 3R makes it clear that “a business need not include all of the inputs or processes…if market participants are capable of acquiring the business and continuing to produce outputs, for example, by integrating the business with their own inputs and processes”.

133 In its Effect Analysis, the IASB did not specifically comment on the effects of the change to the definition of a business.

134 Some members believe the language used in IFRS 3R meant that the boundary between acquisition of businesses and acquisition of assets is unclear; and this


32

might lead to difficulties in interpreting whether a transaction involves a business as defined in IFRS 3R. In addition, it is likely to increase the amount of judgement applied by preparers to determine when a transaction is a business combination as defined by IFRS 3R, and when it is not. This uncertainty is likely to involve some additional costs for preparers. For similar reasons, these EFRAG members were not convinced that the additional guidance provided in IFRS 3R on what comprises a business would benefit preparers particularly.

135 However, these EFRAG members also understand that this change will only affect a limited number of companies. These companies are likely to incur some additional costs. One EFRAG member pointed out that EFRAG might want to bring to the attention of the IASB or the IFRIC, the issue relating to the ‘unclear boundary’.

136 Furthermore, some EFRAG members were concerned that the consequence of the broader definition might be that some transactions that were previously considered asset transactions in IFRS 3 might need to be accounted for as business combinations in accordance with IFRS 3R. In other words, the change might have the effect of extending the scope of the standard. In some cases it might be that the potential broadening of the scope might go beyond what the IASB intended when it issued IFRS 3R. The costs for preparers of an extension in the scope of the standard are discussed later.

137 Overall, the majority of EFRAG members did not believe the cost implications associated with the change in the change in the definition of a business, were a significant issue, mainly because only a limited number of companies are likely to be affected by this amendment.


138 Some EFRAG members believe that some users will benefit from this new requirement, at no additional cost to them. The benefits arise mainly because of the enhanced comparability that will arise from the amendment. Other EFRAG members do not, mainly because of the reasons explained above in relation to preparers. However, these EFRAG members also think that the majority of companies are not involved in asset transactions or that such transactions were fairly insignificant.

Conclusion

139 On balance, EFRAG believes that this amendment is unlikely to involve preparers and users with any significant implications on costs and benefits.

Amendment 6: Fair value as a measurement attribute


140 There are two separate amendments to consider under this heading.

(a) Amendment 6A: the removal of the application guidance on fair value—IFRS 3R retains the definition of fair value that is currently used in existing IFRS 3, but omits the application guidance included in B16 of IFRS 3. IFRS 3R also adds guidance to the way some assets and liabilities ought to be classified and designated at the date of the acquisition. It clarifies that an acquirer must consider the terms and conditions relating to assets and liabilities that existed


33

on the date of the acquisition, in respect to the initial classification and designation.

(b) Amendment 6B: IFRS 3R requires more use of fair value than IFRS 3—As explained above in Amendments 1, 3, and 4 (contingent consideration, step acquisitions and partial acquisitions), in some cases IFRS 3R requires greater use of fair value for certain aspects on accounting for business combinations. In other cases, such as the accounting for some aspects of step acquisitions (issue 6), the use of fair value will be reduced.

141 In its Effect Analysis, the IASB states that the changes will only affect contingent consideration and step acquisitions. It further explains that whether an entity will need to make additional, or fewer, fair value measurements will depend on the circumstances of the acquisition and provides some examples to this effect.

142 EFRAG believes that Amendment 6A will involve preparers in additional costs, mainly because preparers are likely now:

(a) to spend more time researching other IFRSs or other GAAPs (like US GAAP) to determine how to apply fair value to the components of the business combination; and/or

(b) to engage valuations experts to provide them with guidance on how to value all (or some) assets and liabilities acquired.

However, EFRAG’s assessment is that these costs will be insignificant.

143 EFRAG has already assessed each of the changes referred to in Amendment 6B elsewhere in this assessment. Therefore, to avoid double-counting, the assessment made under this heading should relate only to the cumulative effect of the change. EFRAG members have different views on this cumulative effect. Some believe that it results in no particular benefits or costs for preparers. Others however believe that it increases disproportionately the risk involved in preparing the business combination numbers and will therefore result in additional costs as preparers (and their auditors) seek to manage that additional risk.

144 EFRAG’s assessment is that the elimination of the guidance in B16 of existing IFRS 3 will not involve preparers in significant additional costs, but that the cumulative effect of the increased use of fair value compared to the existing IFRS 3 could involve some preparers in additional year-one and on-going costs. EFRAG’s assessment however is that these additional costs are unlikely to be significant.


145 In its Effect Analysis, the IASB did not specifically comment on the effects that the increase in the use of fair value or the removal of application guidance on fair value would have on users.

146 When guidance is eliminated, it is always possible that it will result in diversity of practice. EFRAG’s assessment, however, is that it is unlikely that significant diversity will arise on the issues that were addressed in the omitted. EFRAG also understands that one of the areas of particular concern to many users is the area on valuing intangibles at fair value, particularly regarding the seemingly arbitrary allocation of value between different intangible assets. This issue was not covered in the omitted guidance.


34

147 EFRAG’s assessment is therefore that users are unlikely to be affected to any significant degree by this change.

Overall conclusion

148 Therefore, to summarise, EFRAG’s assessment is that the only impact these changes will have on preparers and users is that the cumulative effect of the increased use of fair value compared to the existing IFRS 3 could involve some preparers in additional year-one and on-going costs. However, these additional costs are unlikely to be significant.

Amendment 7: Scope


149 The scope of IFRS 3R has been extended to include business combinations involving mutual entities and cooperative entities and those combinations achieved by contract alone without obtaining an ownership interest.

150 Presently, business combinations involving two or more mutual entities and business combinations achieved by contract alone are not within the scope of IFRS 3; and no other IFRS provides guidance on how to account for the transactions. As a result, these types of combinations are accounted for in different ways. For example, EFRAG understands that currently, while some combinations of mutual entities and those entities combining by contract alone are accounted for in accordance with the acquisition method (as required in existing IFRS 3). Others are accounted for applying the pooling of interests method using the carrying amounts of the assets and liabilities of the combining entities (both acquirer and acquiree).

151 In its Effect Analysis the IASB noted that for those entities that were outside of the scope of IFRS 3, the application of the acquisition method for business combinations is likely to result in a significant change in accounting, because many mutual entities and those entities entering ‘by contract alone’ have been applying the pooling of interests method. Those entities are likely to be faced with significantly higher preparation costs when they implement IFRS 3R.

152 EFRAG agrees that, depending on what accounting has been used in the past to account for business combinations, this change could involve some preparers in significant changes in practice and, as a result, could involve significant implementation costs. However, EFRAG is of the view that the majority of entities would not be affected.


153 The IASB assessed this new requirement to have a positive effect on users, mainly because users will benefit from a reduction in the costs of monitoring different accounting and because the new requirement will result in a significant increase in comparability of financial information relating to business combinations involving mutual entities. The extended scope would require all new business combinations, except for common control transactions and newly formed joint ventures, to be accounted for in the same way.

154 That is EFRAG’s assessment too; the incremental costs for users are likely to be insignificant and in any case users are likely to obtain some benefits from the new requirement.


35

Conclusion

155 Therefore, this new requirement seems likely to involve some preparers in significant implementation costs, although the majority of companies are unlikely to be affected. On the other hand, for users the incremental costs are likely to be insignificant. Users will though benefit from increased comparability and better quality information. Overall, EFRAG’s assessment is that these benefits are likely to exceed the costs.


36

EFRAG’S FINAL ANALYSIS OF THE COSTS AND BENEFITS OF IMPLEMENTING IAS 27A

156 EFRAG’s detailed final assessment of the costs and benefits of IFRS 3R and IAS 27A is presented in the sections below. In developing its final analysis EFRAG has considered:

(a) the input provided by stakeholders on its initial assessment,

(b) the information obtained from preparers who are assessing the effects of implementing the new standards, and

(c) the discussions EFRAG had with users of financial statements regarding the effects to users of the changes to the new standards

157 A summary of the input provided by stakeholders on (a) – (c) is included in section 7 of this report.

158 Similar to its initial assessment, EFRAG based its final assessment on the main changes or amendments that it believed likely to be of most relevance to an assessment of the costs and benefits of implementing IAS 27A.

Reading and understanding the Amendments


159 Whenever accounting requirements change, preparers and users need to read and understand the new requirements and this will inevitably involve incremental year one cost. In this case, preparers will need to assess the impact the changes would have on the financial statements and, in particular, on the entity’s equity should an entity decide to acquire some (or all) of the non-controlling interests (NCI), and how to counteract the effects that transactions with NCI might have on the entity’s equity as well as the consequences thereof. Users will need to understand the underlying rationale that has lead to changes in equity in order to perform their analysis of the numbers reported in the financial statements.

160 EFRAG’s assessment is that these incremental year-one costs to read and understand the amendments will not be significant to preparers or to users.

Transition requirements


161 The main changes in IAS 27A are all required to be applied prospectively for annual periods beginning on or after 1 July 2009. Early adoption is permitted if IFRS 3R is adopted at the same time and the main changes are applied to reporting periods beginning prior to 30 June 2007. As a result, EFRAG’s assessment is that the transition requirements will not result in additional costs to preparers. On the other hand, the lack of comparability that arises from prospective application is likely to result in users incurring additional on-going cost, although EFRAG’s assessment is that the incremental cost involved is not likely to be significant.


37

Amendment 1: Changes in ownership interest that do not result in control of another entity being lost


162 IAS 27A requires preparers to account for transactions with NCI involving acquisitions and disposals of interest in a subsidiary entity without loss of control as equity transactions. No further goodwill will be recognised when a NCI is purchased. Neither will goodwill be derecognised when a NCI is disposed of, and control is not lost.

163 Existing IAS 27 is silent on how these transactions are accounted for. This means that there currently is a divergence of practice, and that some entities will need to change the way they account for such transactions.

164 The IASB assessed that preparation costs would be reduced for such transactions, because the absence of guidance in existing IFRS resulted in some preparers having incurred costs by obtaining professional advice on how to account for these transactions.

165 EFRAG agrees that the amendment is likely to mean some preparers will need less professional advice. EFRAG’s also believes that, depending on the accounting treatment currently being adopted by preparers, the cost of calculating the information needed to comply with the amendment will in most cases be low, relative to the alternative methods, as it does not require any fair value measurements of assets and liabilities. EFRAG’s assessment is that for most preparers these cost savings will probably not be significant.

166 However, preparers might need to monitor transactions involving the purchase of non-controlling interests in order to counteract the reduction in net assets and equity. This will involve setting up tracking procedures and therefore result in some incremental implementation and on-going costs. EFRAG believes that entities with a business model that involves purchases of NCI recognised as part of a business combination will most likely have corresponding tracking procedures in place. The costs of implementing the amendment will thus be limited to assessing the information and monitoring the effects of transactions with NCI. Although this could be quite an extensive exercise for some entities, EFRAG believes that, for preparers as a whole, the year one costs will not be significant.


167 EFRAG has also considered whether the amendment will benefit users of financial statements and/or whether the amendment will in some way increase the burden on users.

168 EFRAG believes that the comparability that will result from having a single method of accounting for such transactions will be significant.

169 On the other hand, it also believes that the amendment might involve some users in some additional costs because it could make less apparent aspects of this type of transaction that some users are particularly interested in. These potential incremental ongoing costs would not however exceed the benefits mentioned in the preceding paragraph.


38

Conclusion

170 Overall, EFRAG’s assessment is that this amendment will impose no significant additional costs on preparers or users, but is likely to result in significant additional benefits for users.

Amendment 2: Changes in ownership interest that result in control of another entity being lost


171 This amendment requires that, when a parent entity loses control of a subsidiary, it should remeasure at fair value any retained ownership interest in the former subsidiary and recognise any resulting gain or loss in the income statement. Existing IAS 27 is silent on the subject.

172 The IASB assessed the costs involved in this amendment to be relatively low, and concluded that the effect for preparers would be neutral. The parent entity will need to make one new fair value calculation; however, in many cases an entity selling a controlling interest will value its entire interest before doing so, which would mean the fair value of the retained interest would be readily available. Furthermore, the exchange transaction undertaken by the parent will assist in measuring the fair value of the investment it has retained. The IASB also thought providing guidance on how to measure a gain or loss on disposal should reduce audit costs and the costs of seeking professional advice, and therefore benefit preparers.

173 EFRAG agrees with the IASB’s assessment and reasoning. EFRAG understands that some preparers generally fair value the entire interest, when undertaking a transaction to dispose of the controlling interest in an entity. For some of these preparers obtaining the fair value of the retained investment, might not pose additional effort (or costs). However, for those entities that do not have the information on fair value of the retained investment, obtaining that valuation will involve additional costs for preparers. For example, some preparers might need to consider changes to their accounting systems and the level of valuation expertise required to estimate the fair values of the ownership interests that are retained in a previously held subsidiary when control in that subsidiary is lost.

174 EFRAG has concluded that, overall, this amendment will not have any significant cost implications for preparers.


175 The IASB assessed the affect on users to be positive. EFRAG agrees that the accounting for loss of control of a subsidiary and the remeasurement of the retained investment will be comparable as all entities will be measuring the gain or loss on disposal on a consistent basis. Going forward, the retained investment will be recognised initially on a consistent basis for all entities. Presently this was not the case, as entities would carry forward the carrying amount, which is likely to be based on mixed measurement models.

176 For similar reasons, EFRAG’s assessment is that, because of the enhanced comparability, some benefit for users will arise from this amendment.


39

177 However, the view of the majority of EFRAG members is that the accounting that IAS 27A requires is not the most appropriate of the alternatives available and this largely offset the benefits to users of having information that is more comparable.

Conclusion

178 EFRAG agrees that the amendment will not have significant incremental cost implications for preparers. Neither will the amendment involve users in significant incremental costs, because users can easily adjust out of earnings the gain resulting from the remeasurement of the retained interest if their analysis requires adjustments for such non-recurring items.

179 However, EFRAG believes that the amendment will result in only limited benefits to users mainly because, as explained above, the benefits of comparability are compromised by accounting that EFRAG believes is inappropriate.

Amendment 3: Accounting for losses attributable to NCI


180 Existing IAS 27 requires losses in a subsidiary that exceed the NCI to be allocated to NCI only if the NCI owners have a binding agreement to fund the losses. In the absence of such an agreement, the losses are attributable to the controlling interest only. If the subsidiary subsequently reports profits, these profits are allocated to the controlling interest until the share of losses previously absorbed by the controlling interest have been recovered.

181 IAS 27A requires losses to be allocated between the controlling interest and NCI based on their proportionate ownership interest, even if that means the NCI becomes a negative number.

182 EFRAG’s assessment is that the amendment will be simpler to apply than the existing requirements, and is therefore likely to result in a reduction in preparation costs.


183 The IASB’s assessment was that this amendment would have no effect on the costs of users. EFRAG shares that view.

184 EFRAG’s assessment is also that some users might find the information provided as a result of the amendment more useful than that provided under existing IFRS. On the other hand, for other users it might be less useful.

185 EFRAG’s assessment is that the amendment is unlikely to affect users in any significant way.

Conclusion

186 Overall, EFRAG’s assessment is that, although the benefits arising from this amendment are likely to exceed the costs, there are not likely to be any significant cost or benefit implications.


40

EFRAG’S OVERALL CONCLUSIONS

Overall cost-benefit considerations on the implementation of IFRS 3R in the EU

187 To summarise, EFRAG reached the following individual final conclusions on each of the amendments discussed on IFRS 3R.

(a) Reading and understanding the amendments—No significant cost or benefit implications are likely.

(b) Additional disclosure—Likely to provide benefits that exceed the costs involved.

(c) Transition requirements—Likely to result in some increased costs for preparers and users, but those costs are not likely to be significant.

(d) Amendment 1: Contingent consideration—The costs and benefits will probably largely balance out.

(e) Amendment 2: Acquisition-related costs—The amendment is unlikely to have significant cost or benefit implications.

(f) Amendment 3: Step acquisitions—The amendments are likely to result in a cost saving for preparers and benefits (but no costs) for users.

(g) Amendment 4: Partial acquisitions – acquisitions of less than 100 percent—The costs of this amendment are likely to exceed the benefits.

(h) Amendment 5: Definition of a business— No significant cost or benefit implications are likely.

(i) Amendment 6: Fair value as a measurement attribute—No significant cost or benefit implications are likely.

(j) Amendment 7: Scope—No significant cost or benefit implications likely.

188 EFRAG’s assessment is that it is Amendments 3 and 4 are the main factors listed above that EFRAG needs to weigh in reaching its overall assessment of the revised standard. EFRAG believes that the net benefits arising from Amendment 3 exceed the net costs arising from Amendment 4.

189 It needs also to be borne in mind that a key objective of revising the existing IFRS 3 was to ensure that the accounting for business combinations is the same whether an entity is applying IFRS or US GAAP. The accounting requirements in IFRS and US GAAP will now be substantially the same, with one key difference: the initial measurement of non-controlling interests. A range of other differences also remain, due to existing differences between other IFRSs and US GAAP. Nevertheless, the fact that IFRS and US GAAP will now be substantially the same will result in benefits for some users.

190 Therefore, EFRAG’s overall assessment is that on balance, the benefits that are expected to arise from the implementation of IFRS 3R in the EU will exceed the costs expected to be incurred.


41

Overall cost-benefit considerations on the implementation of IAS 27A in the EU

191 To summarise, EFRAG reached the following individual final conclusions on each of the amendments discussed on IAS 27A.

(a) Reading and understanding the Amendments—No significant cost or benefit implications are likely.

(b) Transition requirements to IAS 27A— No significant cost or benefit implications are likely.

(c) Amendment 1: Changes in ownership interest that do not result in control of another entity being lost—Likely to result in no significant additional costs but significant benefits for users.

(d) Amendment 2: Changes in ownership interest that result in control of another entity being lost —Likely to result in only insignificant additional costs. However, it will not result in any net benefits for users.

(e) Amendment 3: Accounting for losses attributable to NCI—No significant cost or benefit implications are likely.

192 In other words, the only Amendment that is likely to have a significant effect is Amendment 1, which is expected to result in significant benefits for users.

193 Therefore, EFRAG’s overall assessment is that the benefits that are expected to arise from implementing IAS 27A in the EU will exceed the costs expected to be incurred.

Stig Enevoldsen Chairman, EFRAG 7 November 2008

ANNEX 2

EFRAG endorsement advice on IFRS 3R Business Combinations

1

Jörgen Holmquist Director General European Commission Directorate General for the Internal Market 1049 Brussels

7 November 2008

Dear Mr Holmquist

Adoption of IFRS 3 (Revised) Business Combinations

Based on the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards we are pleased to provide our opinion on the adoption of IFRS 3 (Revised) Business Combinations (IFRS 3R), which was published by the IASB on 10 January 2008. It was issued as an Exposure Draft in June 2005 and EFRAG commented on that draft.

The objective of IFRS 3R is to establish principles and requirements on how an acquirer in a business combination recognises and measures in its financial statements the results of the acquisition transaction. The changes made to existing IFRS 3 by IFRS 3R are intended to:

• ensure that the accounting for business combinations is largely the same whether an entity is applying IFRS or US GAAP; and

• improve the accounting for business combinations, by providing additional requirements and guidance in certain areas and in making the accounting in other areas more internally consistent and more principle-based.

The main changes made are summarised in paragraph 3 of Appendix 1 of this letter.

The amendment becomes effective for annual periods beginning on or after 1 July 2009.Earlier application permitted, as long as it is not applied to an annual accounting period beginning before 30 June 2007.

EFRAG has carried out an evaluation of IFRS 3R. As part of that process, EFRAG issued a draft version of this letter for public comment and, when finalising its advice and the content of this letter, it took the comments received in response into account. EFRAG’s evaluation is based on input from standard setters, market participants and other interested parties, and its discussions of technical matters are open to the public.

EFRAG supports IFRS 3R and has concluded that it meets the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards that:

EFRAG’s endorsement advice letter on IFRS 3 (Revised)

2

• it is not contrary to the ‘true and fair principle’ set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC; and

• it meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.

For the reasons given above, EFRAG believes that it is in the European interest to adopt IFRS 3R and, accordingly, EFRAG recommends its adoption. EFRAG's reasoning is explained in the attached 'Appendix 1 - Basis for Conclusions'.

A minority of EFRAG members (two) have concerns about IFRS 3R that cause those members to believe that EFRAG should not recommend IFRS 3R for endorsement. The reasoning of those members is explained in the attached 'Appendix 2—Dissenting View'.

On behalf of the members of EFRAG, I should be happy to discuss our advice with you, other officials of the EU Commission or the Accounting Regulatory Committee as you may wish.

Yours sincerely,

Stig Enevoldsen EFRAG, Chairman


3

APPENDIX 1 BASIS FOR CONCLUSIONS

This appendix sets out the basis for the conclusions reached, and for the recommendation made, by EFRAG on IFRS 3R.

In its comment letters to the IASB, EFRAG points out that such letters are submitted in EFRAG’s capacity as a contributor to the IASB’s due process. They do not necessarily indicate the conclusions that would be reached by EFRAG in its capacity as advisor to the European Commission on endorsement of the final IFRS or Interpretation on the issue.

In the latter capacity, EFRAG’s role is to make a recommendation about endorsement based on its assessment of the final IFRS or Interpretation against the European endorsement criteria, as currently defined. These are explicit criteria which have been designed specifically for application in the endorsement process, and therefore the conclusions reached on endorsement may be different from those arrived at by EFRAG in developing its comments on proposed IFRSs or Interpretations. Another reason for a difference is that EFRAG’s thinking may evolve.

1 When evaluating the merits of IFRS 3R, EFRAG considered the following key questions:

(a) Are the requirements of IFRS 3R consistent with the IASB’s Framework for the Preparation and Presentation of Financial Statements (‘the Framework’)?

(b) Would IFRS 3R’s implementation result in an improvement in accounting?

(c) Does the accounting that results from the application of IFRS 3R meet the criteria for EU endorsement?

2 Having formed tentative views on the above issues and prepared a draft assessment, EFRAG issued that draft assessment on 30 July 2008 and asked for comments on it by 19 September 2008. EFRAG has considered all the comments received in response, and the main comments received are dealt with in the discussion in this appendix.

3 Under existing IFRS 3, the acquirer measures the cost of the business combination, recognises (with some exceptions) the acquiree’s identifiable assets and liabilities at their acquisition date fair value, and treats any excess of the cost of the business combination over the aggregate acquisition date fair value of the acquiree’s identifiable assets and liabilities as goodwill. From a technical perspective, the main changes that IFRS 3R introduces are as follows.

(a) Under existing IFRS 3, the amount of the consideration was determined and used as the basis for the accounting. IFRS 3R makes three changes to the way the amount of the consideration is calculated:


4

(i) Accounting for contingent consideration (Amendment 1).

Existing IFRS 3 requires contingent consideration to be included in the amount of the consideration for the business combination if and when the additional payment or refund is probable and can be measured reliably. Generally, contingent consideration is measured at the amount the acquirer will be required to pay for the consideration. Subsequent changes to contingent consideration are accounted for as adjustments to the consideration for the acquisition, meaning that goodwill will change. There is no time limit on the adjustment of contingent consideration. Such adjustments are generally made as a result of a change in estimates, or when an amount becomes probable and can be reliably measured.

IFRS 3R requires contingent consideration to be measured at fair value at the date of acquisition. The probability recognition criterion in existing IFRS 3 is deleted. Changes in the fair value of contingent consideration that occur after the measurement period are accounted for in accordance with other IFRSs, which means inter alia that contingent consideration classified as a liability will be remeasured through profit or loss and other contingent consideration (which would be treated as equity) will not be remeasured.

(ii) The treatment of acquisition-related costs (Amendment 2).

Existing IFRS 3 requires that costs directly attributable to the acquisition are included in the cost of the acquisition. Generally, such costs would include costs incurred by the acquirer to accomplish the business combination (legal fees and similar costs). The costs incurred to issue debt or equity securities are recognised in accordance with IAS 32 and IAS 39; meaning that costs for issuing debt are deducted from the debt’s carrying amount and the costs of issuing equity instruments are recognised directly in equity.

IFRS 3R requires all acquisition-related costs to be recognised as expenses at the date of the acquisition, except that the costs to issue debt or equity securities will continue to be recognised in accordance with IAS 32 and IAS 39.

(iii) When the entity obtains control of the acquiree having previously had a non-controlling interest in the acquiree, the acquirer is treated as having given up that pre-existing interest as part of the transaction. The fair value of the pre-existing interest at the date of acquisition is therefore included as part of the consideration amount. This issue is dealt with in this letter under the heading ‘step acquisitions’.

(b) There are changes made to the way in which step acquisitions are accounted for (Amendment 3).

Existing IFRS 3 requires each transaction (each step) to be treated separately; in other words, the acquirer would use the cost and the fair value information at the date of each exchange transaction to determine the amount of goodwill to be recognised, and the goodwill amount recognised at any time would be the sum of all the goodwill that has arisen on each step of the business combination.


5

IFRS 3R requires that, when control is achieved in stages, the fair value of any previously held (ie pre-existing) interest is, as explained in paragraph (a)(iii) above, treated as disposed of and therefore as part of the consideration given to acquire control; and as a result included in the determination of goodwill. Furthermore, any difference between the pre-existing interest’s fair value at the date control is acquired and its carrying amount at that date is recognised in profit or loss.

This means that goodwill from previous purchases is ignored and determined only once: on the date control is obtained.

(c) There are changes made to the way partial acquisitions are accounted for (Amendment 4). The changes have implications both for the amount at which NCI is recognised and the amount at which goodwill is recognised.

In existing IFRS 3, goodwill is recognised only to the extent that it is attributable to the acquirer’s interest in the acquiree; meaning that goodwill is recognised based on the parent’s share of the goodwill. Furthermore, an acquirer measures NCI at its proportionate interest of the fair value of the acquiree’s identifiable net assets.

IFRS 3R permits entities to continue to measure NCI in accordance with the existing IFRS 3. However, it also permits entities to measure NCI at its fair value at the date control is acquired. This is a free choice that can be applied business combination-by-business combination. One effect of exercising this option is that the difference between the fair value of the NCI and the amount at which it is measured initially under existing IFRS 3 (at its proportionate interest of the fair value of the acquiree’s identifiable net assets) would usually increase the amount at which goodwill is measured. This is sometimes referred to as the ‘full goodwill’ method.

(d) IFRS 3R also amends the definition of a ‘business’ (Amendment 5).

(e) IFRS 3R also omits the guidance in existing IFRS 3 on how to apply the fair value measurement requirement to certain assets and liabilities acquired in a business combination (Amendment 6). The above changes to the existing requirements result in greater use of fair value measures when accounting for certain types of business combination; this issue is discussed below under the heading ‘Amendment 6’.

ARE THE REQUIREMENTS OF IFRS 3R CONSISTENT WITH THE IASB’S FRAMEWORK?

4 EFRAG considered whether the new requirements in IFRS 3R are consistent with the IASB’s Framework. For this purpose, it focused on the main changes described in the preceding paragraph.

5 EFRAG believes there are two aspects of the Framework that are relevant to this consideration.

(a) The qualitative characteristics of financial information (relevance, reliability, comparability and understandability). As the Amendments are judged against the qualitative characteristics later in this appendix, this section does not focus on that aspect of the Framework.


6

(b) The material dealing with the elements of financial statements (in particular about the definitions of assets and liabilities).

The consideration given by the acquirer for the business combination

6 The changes made as to the amount to be attributed to the consideration given by the acquirer for the business combination relate primarily to measurement. As the Framework says little about measurement that is definitive, the possibility of the new measurement requirements being inconsistent with the Framework generally does not arise, with two exceptions: contingent consideration and acquisition-related costs.

Amendment 1—Contingent consideration

7 According to paragraph 49 of the Framework, a liability is “a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits”. Paragraph 91 of the Framework explains that a liability is recognised “when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably”.

8 IFRS 3R requires an acquirer to recognise a liability for contingent consideration regardless of how probable it is that the consideration will be paid. Although there is no explanation in IFRS 3R’s Basis for Conclusions as to how this treatment might be reconciled to the Framework, the IASB has argued in other contexts that this removal of the probability threshold is consistent with the Framework because it is certain both that the acquirer has an obligation (a stand-ready obligation) and that there will be an outflow of resources (because the mere act of standing-ready to pay involves an outflow of resources).

9 However, EFRAG does not accept this argument. Even if one accepts that a stand-ready obligation is the sort of obligation envisaged in the liability definition, the mere act of standing-ready to pay does not necessarily involve an outflow of resources. Therefore, in EFRAG’s view the effect of the new treatment of contingent consideration will sometimes be to recognise liabilities that do not meet the Framework’s recognition criteria.

10 EFRAG notes that the IASB argues that IFRS 3R’s treatment of contingent consideration is necessary because otherwise the acquisition date accounting would ignore the fact that the acquirer has agreed to make contingent payments. It also noted that there are a number of other instances in existing IFRS, most or all of which also involve the use of fair value measures, where this inconsistency with the Framework arises.

11 For the above reasons, although EFRAG believes that this aspect of IFRS 3R is not consistent with the Framework, the majority of EFRAG members believe the inconsistency is acceptable. Other EFRAG members however do not.

Amendment 2—Acquisition-related costs

12 IFRS 3R changes the accounting for acquisition-related costs. The IASB justifies this new treatment by arguing that acquisition-related costs do not represent assets of the acquirer at the acquisition date because the benefits obtained are consumed as the services are received—which in their view is the date of the acquisition.


7

However, according to paragraph 49 of the Framework, an asset is “a resource controlled by the enterprise as a result of a past event and from which future economic benefits are expected to flow to the enterprise”. In other words, assets are resources, not costs. Costs are amounts used to measure assets. Therefore, it is EFRAG’s view that the argument used to justify this new treatment of acquisition-related costs is not valid.

13 On the other hand, EFRAG also believes that whether acquisition-related costs are included as part of the cost of the business combination is a measurement issue—and the Framework says little about measurement that is definitive. Therefore, the possibility of the new measurement requirements being inconsistent with the Framework does not arise.

Amendment 3—Step acquisitions

14 EFRAG believes that the Framework says nothing that is of relevance to IFRS 3R’s treatment of step acquisitions.

Amendment 4—Partial acquisitions

15 As already explained, the changes to the requirements for partial acquisitions relate mainly to the treatment of NCI and goodwill. The principle on which the fair valuing of NCI/full goodwill methodology is based is that the consolidation model should present consolidated financial statements as a single economic entity (entity perspective), rather than the mixed entity/parent perspective that is used in IFRS currently. Therefore the goodwill recognised should not be just the proportionate goodwill arising on the parent shareholders’ interest in the subsidiary; it should include goodwill arising on the NCI, too. That way, the goodwill arising on the entity’s acquisition of the subsidiary is recognised.

16 In EFRAG’s view, the entity or parent perspective is not something that is addressed fully in the Framework. Some issues are addressed, but others are not. For example, under the Framework, NCI is equity. However, it does not follow that, just because NCI is equity, an entity perspective has to be applied.

17 On the other hand, the Framework is silent on a number of issues that would have an impact on the perspective chosen. For example, it is not clear which entity is the reporting entity when consolidated financial statements are prepared: the parent or the group. Because of this absence of material in the Framework, EFRAG concluded that Amendment 4 is not inconsistent with the Framework.

Amendment 5—Definition of a business & Amendment 6—Fair value as a measurement basis

18 EFRAG believes that the Framework says nothing that is of relevance to Amendments 5 or 6.

Conclusion

19 Because of this absence of material in the Framework, EFRAG concluded that IFRS 3R is not inconsistent with the Framework except in one respect (Amendment 1), where the majority of EFRAG members thought the inconsistency was acceptable.


8

WOULD IFRS 3R’s IMPLEMENTATION RESULT IN AN IMPROVEMENT IN ACCOUNTING?

20 EFRAG next asked itself whether the changes to IFRS contained in IFRS 3R were likely to result in an improvement in the financial information provided. For this purpose, EFRAG assessed each of the Amendments already described in turn.

Amendment 1—Accounting for contingent consideration

Initial measurement

21 The majority of EFRAG members are of the view that the requirement to recognise the acquisition date fair value of any contingent consideration as part of the consideration amount for the business combination will result in an improvement in the information provided. That is because they believe that a delay in recognising liabilities that are contingent on a future outcome or event could cause financial statements to be incomplete and thus diminish their usefulness in making economic decisions. However, one EFRAG member is concerned about the apparent ‘disconnect’ between IFRS 3R and the requirements in IAS 37 created by this change (the removal of the ‘probability’ criterion meant that liabilities were measured differently under IFRS 3R and IAS 37) and the implications that this could have for the subsequent accounting.

22 The change will result in the need for additional estimates to be made, but most EFRAG members believe that this will not be a significant issue; the use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability as long as the estimates used can be reasonably determined. Some EFRAG members however noted that this was yet another area in which estimation and judgement was needed in acquisition accounting and, taken as a whole, the degree of estimation and judgment involved was now becoming a concern. (This concern is discussed further under Amendment 6.)

Subsequent measurement

23 The majority of EFRAG members had some concerns about IFRS 3R’s requirement that subsequent changes in the fair value of any contingent consideration liability should be recognised in profit or loss; and that if the contingent consideration did not result in a liability, no adjustment at all should be made for fair value changes.

(a) Some were concerned that having more values based on information that required a high degree of estimation introduced volatility in profit or loss, rendering the financial statements less relevant to users.

(b) Some noted that there are several reasons why a buyer and seller enter into contingent consideration, but argued that, where the changes in fair value reflected an uncertainty about the value of the business at the acquisition date, they should be accounted for as part of the cost of the acquisition rather than in profit or loss.

24 Some EFRAG members saw some benefits in the change. In particular:

(a) Some EFRAG members believe that in a business combination most contingent payments would be linked to the future performance of the acquired entity and in such cases it made sense for changes to the performance-based consideration to be recognised in profit or loss. In effect,


9

they were post-acquisition events, which generally are recognised in profit or loss. Accounting for changes that arise from changes in future performance targets, as an adjustment to goodwill, would create a ‘mismatch’ in the financial statements.

(b) Some EFRAG members also believe that the new requirements for contingent consideration would improve comparability of financial reporting because all contingent arrangements in business combinations would be accounted for in same way.

Conclusion

25 The majority of EFRAG members have concluded that some aspects of Amendment 1 are likely to result in an improvement in the information provided, some are likely to have the opposite effect, and overall they probably balance out.

Amendment 2—Accounting for acquisition-related costs

26 The majority of EFRAG members believe that expensing acquisition-related costs makes it difficult for the financial statements to fulfil their stewardship objective because the acquirer is not made accountable for the full cost invested in the business combination. However, some other members do not agree; in their view the Amendment will have no significant impact on the quality of the information provided.

Amendment 3—Step acquisitions

27 The majority of EFRAG members agree that Amendment 3 is likely to result in an improvement in the information provided, because presently practices diverge, which compromises comparability. The majority also agree that achieving control is a significant event, and some thought this justified remeasuring the pre-existing interest and recognising a gain or loss in profit or loss. In their view the acquirer had given up an NCI and acquired a controlling interest, and fair valuing the asset given up was the usual practice in non-cash exchange transactions. Some others thought that, although such an exchange has not taken place, remeasurement is still appropriate due to the event of control being achieved.

28 However, others were not convinced, arguing that the pre-existing interest (the NCI) has merely been transformed, not given up, and is therefore not part of the exchange. In their view, the treatment required by the Amendment could misrepresent the transaction.

Amendment 4—Partial acquisitions

29 IFRS 3R permits entities to continue to measure NCI in accordance with the existing IFRS 3. However, it also permits entities to measure NCI at its fair value at the date control is acquired. EFRAG members believe two issues arise from this; they are discussed separately below.

Fair value as a measurement attribute for NCI

30 EFRAG considered the effect that measuring NCI initially at fair value and recognising ‘full goodwill’ would have on the information provided. EFRAG noted that the general principle to fair value NCI is consistent with the general approach in IFRS 3R that all components shall be measured at fair value.


10

31 Although there were some concerns about whether NCI could be measured at fair value reliably, EFRAG recognised that the existence of an option addressed such concerns.

32 Some EFRAG members thought that measuring NCI at fair value was an aspect of the entity perspective and, in their view, applying the entity perspective would not provide information that is relevant to the primary users of consolidated financial statements, the shareholders of the parent entity.

33 Although the majority of EFRAG members did not share this concern, few of them thought that being able to fair value NCI and being able to recognise full goodwill would result in a general improvement in the information provided. They noted though that this accounting treatment was not mandatory, and would therefore probably be most used in exactly the circumstances in which it does result in improvements.

The option

34 EFRAG also considered what the effect would be on the information provided of introducing into IFRS a transaction-by-transaction choice as to how to measure NCI and goodwill.

35 EFRAG believes as a matter of principle that options in standards generally reduce the usefulness of the resulting information. Furthermore, some EFRAG members thought that the IASB was permitting “options” on an ad-hoc basis depending on circumstances, and this was having an effect on the consistency and, as a result, on the quality of the information provided.

36 On the other hand, the majority of EFRAG members accept that there are some circumstances in which fair valuing some or all of the NCI can result in an improvement in the information provided. In their view, having an option allows NCI to be fair valued in those circumstances, without requiring NCI to be fair valued in other circumstances. Furthermore, as already mentioned, having an option also leaves room for an alternative approach to be adopted when it is difficult to estimate NCI’s fair value. Some EFRAG members also believe it is relevant that NCI is not usually significant compared to total equity.

37 Another concern that some members had was that the existence of this option in IFRS 3R appears not to have been reflected fully in the standard’s other requirements. In other words, the standard’s other requirements largely assume that NCI will be recognised initially at fair value and as a result take insufficient account of the fact that that will not always be the case. However, the majority of EFRAG members did not see this as a major concern.

Conclusion

38 The majority of EFRAG members believe that fair valuing NCI and recognising full goodwill will not have a significant effect on the quality of the information provided. The existence of a free choice that can be exercised on a transaction-by-transaction basis has advantages and disadvantages in terms of the information provided.

39 On balance, the majority of EFRAG members believe that, if judged in isolation, the inclusion of a transaction-by-transaction choice would not improve the information provided. However, EFRAG understands that, had this option not been included in


11

IFRS 3R, it might not have been possible for the IASB to revise existing IFRS 3 and that, as a result, the inclusion of this option made the improvements that IFRS 3R makes possible. Therefore, this option is best judged in the context of the revised standard as a whole.

Amendment 5—Definition of a business

40 IFRS 3R has changed the definition of ‘a business’. EFRAG believes that the main change to the definition itself is the introduction of the word “capable”, which has the effect of broadening the definition. EFRAG understands that the purpose of this change is to make it clear that a business does not need to include all the inputs or processes that the seller used as long as market participants would be capable of operating the business by integrating it into its own inputs and processes. This point is reiterated in the guidance accompanying the amended definition.

41 The majority of EFRAG members thought this change in definition and additional guidance would not have a significant practical effect in most cases. In their view, transactions that would not fall under the definition in existing IFRS 3 would also not fall within the new definition.

42 However, some EFRAG members were concerned that the revised definition and guidance—particularly the guidance about market participants—might bring into the scope of IFRS 3R transactions that were better accounted for in other ways and that what they saw as a lack of clarity in the revised definition might result in a divergence of practice.

Amendment 6—Fair value as a measurement attribute

Guidance on fair value measurement

43 Although there has been no change to the definition of ‘fair value’ in existing IFRS 3, the guidance on how to measure certain assets and liabilities at fair value that was in the existing standard has been omitted from IFRS 3R. Some EFRAG members were concerned about this omission because they regarded the guidance as pragmatic, practical and useful. They thought a result of the omission could be that the fair value notion would be inconsistently applied in practice. However, the majority of EFRAG members were not concerned about the issue. In their view, the guidance in paragraph B16 of existing IFRS 3 is not consistent with the fair value measurement objective. Omitting the guidance eliminates this inconsistency. They also noted that there was sufficient material in the existing literature on fair value measurement to understand the concept in the context of business combinations.

Increase in the use of fair value measures

44 IFRS 3R requires greater use of fair value than hitherto, in that:

(a) any contingent consideration is required to be measured at fair value on initial recognition and the components that are classified as liabilities are required to be remeasured at fair value too,

(b) any pre-existing interest needs to be measured at fair value if and when control is acquired, and

(c) there is an option to measure any NCI at fair value.


12

45 Some EFRAG members are concerned about this increased use of fair value because, when taken together with the amount of fair value that existing IFRS 3 already requires to be used, the degree of estimation and judgment involved in acquisition accounting has now become in their view very significant. However, the majority of EFRAG members do not share this concern: in their view the use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability as long as the estimates used can be reasonably determined.

Does the accounting that results from the application of IFRS 3R meet the criteria for EU endorsement?

46 In summary, EFRAG has concluded that IFRS 3R is not inconsistent with the Framework except in one respect (Amendment 1), where the majority of EFRAG members thought the inconsistency was acceptable. Furthermore, having considered whether the various amendments in IFRS 3R were likely to improve the information provided, the majority of EFRAG members believe that:

(a) aspects of Amendment 1 are likely to result in an improvement in the information provided, some are likely to have the opposite effect, and overall they probably balance out;

(b) Amendments 2, 5 and 6 are not likely to have a significant impact on the quality of the information provided;

(c) Amendment 3 is likely to result in an improvement in the quality of the information provided; and

(d) the actual accounting change required by Amendment 4 is not likely to have a significant effect on the quality of the information provided, but the decision to allow a transaction-by-transaction choice would not improve the information provided but had to be judged in the context of the revised standard as a whole (because, had the option not been included, it might not have been possible for the IASB to issue a revised version of IFRS 3).

47 Against this background, EFRAG has considered whether IFRS 3R meets the requirements of the European Parliament and of the Council on the application of international accounting standards, in other words that IFRS 3R:

(a) is not contrary to the ‘true and fair principle’ set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC; and

(b) meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.

EFRAG has also considered whether it is in the European interest to adopt IFRS 3R.

48 In this context, it is worth noting that EFRAG has previously concluded that the existing IFRS 3 meets the endorsement criteria.


13

Relevance

49 According to the Framework, information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. EFRAG considered whether the implementation of IFRS 3R would result in relevant information being omitted from the financial statements. It noted that:

(a) as explained in paragraph 23 above, the majority of EFRAG members had concerns about Amendment 1’s subsequent remeasurement requirements, which have the effect of requiring certain items that were previously treated as part of the consideration amount to be either expensed immediately or not adjusted for at all. As a result, some members were concerned that the Amendment might have the effect of obscuring or omitting relevant information. EFRAG noted that IFRS 3R adopted a different approach to changes in estimates relating to contingent consideration compared to IFRS 3; but the approach adopted was consistent with that adopted in other standards that had been assessed to be relevant. EFRAG also noted that Amendment 1 would ensure that the amount of consideration recognised at the date of acquisition included an amount for contingent consideration. This would improve the relevance of the information provided.

(b) the majority of EFRAG members believe that Amendment 2’s treatment of acquisition-related costs means that information that is needed for “assessing the stewardship of management” will be obscured, although they note that IFRS 3R requires disclosure of the amount of acquisition-related costs expensed.

(c) some concerns had been raised about whether Amendment 4’s focus on the entity perspective would result in relevant information being omitted from the financial statements. However, the majority of EFRAG members do not share the concern; in their view the application of the entity perspective resulted in the provision of some information that was different from that provided under the parent perspective, but no less relevant. They also noted that IFRS 3R also requires the disclosure of information that would help in adjusting the information onto a parent perspective should that be considered necessary.

50 Having weighed up these matters, the majority of EFRAG members concluded that IFRS 3R met the relevance criterion.

Reliability

51 The Framework explains that information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent. EFRAG considered whether the implementation of IFRS 3R would result in reliable information being included in the financial statements. It noted that some members were concerned about the increased use of fair value in accounting for business combinations, and about whether it would always be possible to fair value contingent consideration reliably. However, although some members have concluded as a result of these concerns that the reliability criterion is not met, the majority of EFRAG members have concluded that IFRS 3R still meets the criterion.


14

Understandability

52 Financial information provided should be readily understandable by users with a reasonable knowledge of business and economic activity and accounting and the willingness to study the information with reasonable diligence.

53 There is no doubt that some aspects of IFRS 3R involve new notions and will require users to look at aspects of a business combination in a different way than hitherto. However, apart from the comparability issues discussed in the next section, EFRAG does not have any concerns about the understandability of the information that would be provided under IFRS 3R.

Comparability

54 The notion of comparability requires that like items and events are accounted for in a consistent way through time and by different entities, and that unlike items and events should be accounted for differently.

55 Amendment 3’s new requirements for step acquisitions will, EFRAG believes, result in significant improvements in the comparability of the information provided. IFRS 3R contains numerous other, more minor, clarifications that will also improve the comparability of the information provided. IFRS 3R is also largely converged with US GAAP, which means that comparability has also been enhanced globally by this standard. However, there is no doubt that Amendment 4’s transaction-by-transaction choice will have a negative impact on the comparability of NCI and goodwill numbers, and related information (such as goodwill impairment losses). Some EFRAG members also have some concerns about the comparability implications of Amendments 5 (definition of a business) and 6 (omitting the fair value guidance). The fact that the standard is to be applied prospectively to business combinations that take place after the effective date raises further comparability issues.

56 Different EFRAG members attribute different weight to these issues and some EFRAG members do not believe IFRS 3R meets the comparability criterion. However, the majority of EFRAG members believe that it does meet the comparability criterion.

True and Fair

57 For the reasons set out above, EFRAG sees no reason to believe that IFRS 3R is inconsistent with the true and fair view requirement.

European Interest

58 EFRAG members considered whether the benefits of implementing IFRS 3R in the EU exceed the costs of doing so. On balance, EFRAG concluded that the benefits that are expected to arise from implementing IFRS 3R in the EU will exceed the costs expected to be incurred to implement IFRS 3R.

Conclusion

59 After considering all the above arguments, the majority of EFRAG members concluded that on balance IFRS 3R satisfies the criteria for EU endorsement. EFRAG therefore recommends its endorsement.


15

APPENDIX 2 DISSENTING VIEW

The views of two EFRAG members who voted against recommending endorsement of IFRS 3R are explained in this appendix.

Two EFRAG members (Mr Michael Starkie and Mr Carsten Zielke) believe that IFRS 3R should not be endorsed for use in the European Union and therefore dissent from EFRAG's decision to recommend its endorsement. These EFRAG members have reached this conclusion because they believe aspects of IFRS 3R do not meet the endorsement criteria. In particular:

Relevance

1 IFRS 3R changes the way that contingent consideration is accounted for. Mr Michael Starkie and Mr Carsten Zielke believe that the new requirements result in the provision of information that is not relevant to users of financial statements. Specifically, in the case of an arrangement for contingent consideration, they believe that most of the changes in the fair value of the liability for contingent consideration will reflect uncertainty about the value of the business at the acquisition date and therefore should be dealt with by adjusting goodwill; recognising them as gains and losses in profit or loss means that information that is of no relevance to the entity’s performance is being included in a performance statement.

2 IFRS 3R requires acquisition-related costs to be expensed at the date of the acquisition. Mr Michael Starkie and Mr Carsten Zielke believe that such costs are part of the exchange transaction and should therefore be included in the investment amount. In their view, it is the total investment value that preparers of financial statements will be monitoring, and for which preparers have a stewardship responsibility. Therefore, by requiring the costs to be expensed immediately, IFRS 3R will obscure information that is needed for assessing the stewardship of management. They acknowledge that IFRS 3R requires disclosure of the amount of acquisition-related costs expensed, but point out that disclosure cannot make up for inappropriate accounting.

3 IFRS 3R also changes the way that step acquisitions are accounted for. Mr Michael Starkie and Mr Carsten Zielke believe that these new requirements also result in the provision of information that is not relevant to users of financial statements. Specifically, they believe that the requirement to recognise the effect of remeasuring any pre-existing interest in the acquiree at fair value through profit or loss results in the provision of information that has nothing to do with the performance of the entity in profit or loss. In their view, if there is to be a remeasurement of the pre-existing interest, the resulting gains and losses should be recognised in equity.

4 IFRS 3R requires the application of an entity perspective accounting model. Mr Michael Starkie and Mr Carsten Zielke believe that applying that model does not result in the provision of information that is relevant to the primary users of consolidated financial statements, the shareholders of the parent entity. In particular, they believe that the relevant NCI and goodwill amounts are those calculated in accordance with existing IFRS 3; in their view therefore, IFRS 3R’s option to measure NCI at fair value will if exercised result in this relevant information being obscured in the financial statements.


16

Reliability

5 IFRS 3R requires greater use of fair values than hitherto. Mr Michael Starkie and Mr Carsten Zielke believe that, when taken together with the existing requirements in IFRS 3 to use fair value, the use of estimates and judgement involved in a business combination has now become very significant. They believe that this high degree of estimation will mean that often some of the information provided on the business combination will not be reliable.

Comparability

6 IFRS 3R introduces an option on a transaction-by-transaction basis on how to measure the NCI. There is no doubt that the use of alternative accounting treatments in accounting reduces the comparability of financial information, and more so if the alternative treatment can be used on a case-by-case basis, as it can in IFRS 3R. In the view of Mr Michael Starkie and Mr Carsten Zielke, allowing a free choice option as to how to measure NCI will mean that the information provided about business combinations will often not be comparable.

Cost/benefit

7 IFRS 3R, like IFRS 3, requires the identifiable net assets acquired by the acquirer as a result of the acquisition to be recognised. Mr Michael Starkie and Mr Carsten Zielke believe that the outcome of IFRS 3 already often is an arbitrary allocation of value between different intangibles. The added emphasis in IFRS 3R to recognise intangibles separately from goodwill will increase the complexities associated with recognising intangibles separately from goodwill, and therefore will involve additional costs being incurred by preparers. However, it will not enhance the usefulness of the information provided, because in most cases users do not consider the fair values of individual asset categories to be of particular relevance, rather they tend to focus on the value of businesses (collection of assets) and their ability to generate a stream of future cash flows. As such, the costs incurred will not result in commensurate benefits.

ANNEX 3

EFRAG endorsement advice on IAS 27A Consolidated and Separate Financial Statements

1

Jörgen Holmquist Director General European Commission Directorate General for the Internal Market 1049 Brussels

7 November 2008

Dear Mr Holmquist

Adoption of the Amendment to IAS 27 Consolidated and Separate Financial Statements

Based on the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards we are pleased to provide our opinion on the adoption of the Amendment to IAS 27 Consolidated and Separate Financial Statements (IAS 27A), which was published by the IASB on 10 January 2008. It was issued as an Exposure Draft in June 2005 and EFRAG commented on that draft.

IAS 27A specifies the circumstances in which an entity must prepare consolidated financial statements and the accounting treatments to be applied when there have been changes in the level of ownership interest in a subsidiary and or a loss of control of a subsidiary.

The main changes made by IAS 27A to existing IAS 27 are summarised in paragraph 3 of Appendix 1 of this letter.

The amendments being introduced through IAS 27A become effective for annual periods beginning on or after 1 July 2009, with earlier application permitted subject to the application from that same earlier date of the revised IFRS 3 Business Combinations.

EFRAG has carried out an evaluation of IAS 27A. As part of that process, EFRAG issued a draft version of this letter for public comment and, when finalising its advice and the content of this letter, it took the comments received in response into account. EFRAG’s evaluation is based on input from standard setters, market participants and other interested parties, and its discussions of technical matters are open to the public.

EFRAG supports IAS 27A and has concluded that it meets the requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards that:

• it is not contrary to the ‘true and fair principle’ set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC; and

EFRAG’s endorsement advice letter on IAS 27A

2

• it meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.

For the reasons given above, EFRAG believes that it is in the European interest to adopt IAS 27A and, accordingly, EFRAG recommends its adoption. EFRAG's reasoning is explained in the attached 'Appendix 1 - Basis for Conclusions'.

A minority of EFRAG members (two) have concerns about IAS 27A that cause those members to believe that EFRAG should not recommend IAS 27A for endorsement. The reasoning of those members is explained in the attached 'Appendix 2—Dissenting View'.

On behalf of the members of EFRAG, I should be happy to discuss our advice with you, other officials of the EU Commission or the Accounting Regulatory Committee as you may wish.

Yours sincerely

Stig Enevoldsen EFRAG, Chairman


3

APPENDIX 1 BASIS FOR CONCLUSIONS

This appendix sets out the basis for the conclusions reached, and for the recommendation made, by EFRAG on IAS 27A.

In its comment letters to the IASB, EFRAG points out that such letters are submitted in EFRAG’s capacity as a contributor to the IASB’s due process. They do not necessarily indicate the conclusions that would be reached by EFRAG in its capacity as advisor to the European Commission on endorsement of the final IFRS or Interpretation on the issue.

In the latter capacity, EFRAG’s role is to make a recommendation about endorsement based on its assessment of the final IFRS or Interpretation against the European endorsement criteria, as currently defined. These are explicit criteria which have been designed specifically for application in the endorsement process, and therefore the conclusions reached on endorsement may be different from those arrived at by EFRAG in developing its comments on proposed IFRSs or Interpretations. Another reason for a difference is that EFRAG’s thinking may evolve.

1 When evaluating the merits of IAS 27A, EFRAG considered the following key questions:

(a) Are the requirements of IAS 27A consistent with the IASB’s Framework for the Preparation and Presentation of Financial Statements (‘the Framework’)?

(b) Would IAS 27A’s implementation result in an improvement in accounting?

(c) Does the accounting that results from the application of IAS 27A meet the criteria for EU endorsement?

2 Having formed tentative views on the above issues and prepared a draft assessment, EFRAG issued that draft assessment on 30 July 2008 and asked for comments on it by 19 September 2008. EFRAG has considered all the comments received in response, and the main comments received are dealt with in the discussion in this appendix.

3 IAS 27A in effect proposes three amendments to existing IAS 27, all of which affect the accounting treatment of Non-controlling Interests (NCI). They relate to:

(a) the accounting for changes in ownership interests in subsidiaries that do not result in control of another entity being lost (Amendment 1).

Existing IAS 27 is silent on how to account for changes in ownership interest that do not involve a loss of control in the subsidiary.

IAS 27A treats transactions between the parent and the NCI holders as being transactions that do not involve the reporting entity; therefore any ‘gains’ or ‘losses’ are treated as movements between components of equity and are not recognised in profit or loss.


4

(b) the accounting for changes in ownership interests in subsidiaries that result in control of another entity being lost (Amendment 2).

Existing IAS 27 requires any equity interest retained in the former subsidiary to be measured at its carrying amount (i.e. no remeasurement is required). This means that, when control is lost, a gain or loss is recognised only for the ‘realised’ portion of the interest disposed of.

IAS 27A requires a parent entity to measure any retained investment in the former subsidiary at fair value when it loses control of that subsidiary. It further requires any difference between the carrying amount of the retained investment immediately prior to losing control and its fair value to be recognised in profit or loss, along with any gain or loss on the interest disposed of. It clarifies that the gain or loss arising on loss of control of a subsidiary includes the parent’s share of gains and losses relating to the former subsidiary’s assets and liabilities that were recognised previously in equity.

(c) the allocation of losses to controlling and non-controlling interest in a subsidiary (Amendment 3).

Existing IAS 27 requires losses in a subsidiary that exceed the NCI interest to be allocated to NCI only if the NCI have a binding agreement to fund the losses. In the absence of such an agreement, the losses are attributable to the controlling interest only. If the subsidiary subsequently reports profits, these profits are allocated to the controlling interest until the share of losses previously absorbed by the controlling interest have been recovered.

IAS 27A changes the way losses are allocated between the parent and NCI by requiring profit or loss for the period and other comprehensive income to be attributed to the parent and to the NCI in proportion to their ownership interests. This accounting will apply even if it results in NCI having a deficit balance.

Are the requirements of IAS 27A consistent with the IASB’s Framework?

4 EFRAG considered whether the requirements of IAS 27A are consistent with the IASB’s Framework. For this purpose, it focused on the main changes described in paragraph 3.

5 EFRAG believes there are several aspects of the Framework that are of particular relevance to this consideration.

(a) The qualitative characteristics of financial information are relevance, reliability, comparability and understandability. As IAS 27A will be judged against the qualitative characteristics later in this appendix, this section does not focus on that aspect of the Framework.

(b) The Framework definitions of ‘liability and ‘equity’.


5

(c) The Framework definitions of ‘income’ and ‘expenses’, and its explanation that contributions from equity holders are not income and distributions to equity holders are not expenses.

Amendment 1—Changes in ownership interest that do not result in control of another entity being lost

6 Under the Framework, a Non-controlling Interest is equity—which is also how it is classified under both IFRS 3R and IFRS 3. A transaction that involves a change of ownership without loss of control is therefore a transaction between equity holders. Under IAS 27A, any ‘gain’ or ‘loss’ that arises on a change in ownership interest that does not involve a loss of control is treated as an increase or decrease in equity that is not income or expense. The question that EFRAG therefore considered was whether it was consistent with the Framework to treat these ‘gains’ and ‘losses’ arising from transactions between equity holders as something other than income and expenses.

7 The Framework defines ‘income’ and ‘expenses’ in terms of changes in ownership interest that do not relate to distributions to equity participants. It does not however define what it means by ‘a contribution from an equity participant’ or ‘a distribution to an equity participant’. Although ‘gains’ (‘losses’) arising from changes in ownership interest that do not involve a loss of control will clearly result in an increase (decrease) in equity, it is not clear whether the increases and decreases relate to contributions from or distributions to equity participants. Typically, a contribution from an equity participant will involve that participant giving something of value to the entity and receiving in return an equity interest, but that is not necessarily always the case.

8 EFRAG’s view therefore is that the Framework is not definitive on the issue, so Amendment 1 is not inconsistent with the Framework.

Amendment 2—Changes in ownership interest that result in control of another entity being lost

9 EFRAG considered whether the treatment required by Amendment 2—when the parent has disposed of an interest in another entity and, as a result, loses control of that second entity—is consistent with the Framework definitions of ‘income’ and ‘expense’.

10 When changes in ownership interest that do not involve a loss of control were considered earlier, EFRAG noted that we were discussing a transaction between equity participants. That would not be true in this case, so the possibility of any ‘gain’ or ‘loss’ arising on the transaction being a contribution from or distribution to equity participants also does not appear to arise. Thus, EFRAG believes it is consistent with the Framework to treat the ‘gain’ or ‘loss’ as income and expense.

Amendment 3—Accounting for losses attributable to NCI

11 The Framework does not directly address the allocation of income and expenses between the different components of equity. As a result, EFRAG believesthe Amendment 3 is not inconsistent with the Framework.


6

Conclusion

12 Having taken the above considerations into account, EFRAG concluded that IAS 27A was not inconsistent with the IASB’s Framework.

Would IAS 27A’s implementation result in an improvement in accounting?

13 EFRAG then asked itself whether the application of IAS 27A was likely to result in an improvement in the information provided to users.

Amendment 1—Changes in ownership interest that do not result in control of another entity being lost

14 EFRAG understands that currently at least six different methods are being applied in practice to account for changes in ownership interest without loss of control. IAS 27A requires a single approach to be applied.

15 EFRAG believes that adopting a single approach will significantly improve the comparability of the financial information reported in the consolidated financial statements, as all entities will now account for changes in ownership interest in controlled subsidiaries in the same way.

16 However, it is always possible that the single approach required is not an appropriate approach. EFRAG considered whether that is the position in this case. EFRAG members had differing views on the issue and attached different weights to those views.

17 Some EFRAG members had concerns as to whether Amendment 1 required the most appropriate accounting. In their view:

(a) An approach whereby more goodwill (and more net assets) would be recognised on further acquisitions might have resulted in better information, at least in some circumstances. These EFRAG members noted that it could be questioned why goodwill can be measured only once—at the date control had been initially achieved—particularly when the NCI had been initially measured at its proportionate interest in the net assets acquired instead of at fair value. In their view, it would be better accounting were additional goodwill recognised when a parent acquires further interest in a subsidiary.

(b) It is more appropriate to recognise the ‘gains’ and ‘losses’ that arise on transactions that involve changes in ownership in profit or loss rather than as an equity movement. Recognising the ‘gains’ and ‘losses’ as an equity movement could result in them being obscured from view. In the view of these EFRAG members, NCI holders do not always share in the same risks and benefit from the same rewards as the parent entity shareholders. Thus it was not clear to those members why NCI holders should always be treated in the same way as the parent entity shareholders, and consequently why the equity of the “group” should be affected when additional interest was acquired or disposed of.

(c) the most appropriate accounting might also depend on which option had been selected to measure NCI initially under IFRS 3R.


7

18 However, other EFRAG members thought the accounting required by Amendment 1 represented an improvement in accounting. In their view:

(a) It is well-accepted practice to base the accounting in the area of acquisitions on whether control exists. If control exists, the acquiree’s assets and liabilities are treated, for the purposes of the consolidated financial statements, as if they are the acquirer’s assets and liabilities. For this purpose, an entity either has control or it does not have control. It would seem rather odd to recognise “more assets” when a controlling interest is increased further.

(b) Existing accounting is a mixture of two perspectives—the economic entity perspective and the parent perspective—that are based on different accounting models and produce different accounting outcomes when applied to transactions between a parent and the NCI. The use of a “mixture” of two fundamentally different perspectives has created accounting inconsistencies in the way some transactions are accounted for in the consolidated financial statements. Amendment 1 eliminates those inconsistencies.

19 On balance, the majority of EFRAG members believe the specific accounting required by Amendment 1 is an improvement compared to the alternatives. Taking the improvement in comparability into account, the majority also believes that the Amendment will improve the quality of the information provided.

Amendment 2—Changes in ownership interest that result in control of another entity being lost

20 EFRAG agrees that Amendment 2 will require entities to measure the gain or loss on a consistent basis, thereby also requiring a consistent basis for determining the initial value of the retained investment. This will increase the comparability of the information provided both when control in the subsidiary is lost and when the retained investment is recognised for the first time in the consolidated financial statements.

21 Again, the issue is whether this enhanced comparability has been achieved by adopting a single approach that is not an improvement on the alternatives. EFRAG considered that issue. EFRAG members had differing views on the issue and attached different weights to those views.

22 Some EFRAG members believed the accounting required is an improvement on the alternatives. In their view:

(a) On the loss of control, the parent-subsidiary relationship ceases to exist—so from the group’s perspective the parent should derecognise what it had recorded in its books (the individual assets, liabilities and equity related to that subsidiary)—and a new interest in the former subsidiary has been acquired. In other words, a non-cash asset has been exchanged for cash and/or another non-cash asset. In such circumstances, the usual accounting is to value the non-cash assets and take the overall profit or loss on the transaction to profit or loss.

(b) The parent’s share of gains and losses relating to those assets and liabilities that were recognised previously in equity should to be recognised in profit or


8

loss when control of the subsidiary to which the net assets relate to is lost. The Amendment ensures that the accounting is consistent with the way ‘recycling’ from equity is accounted for in third party transactions, for example when a subsidiary sells an available-for-sale financial asset. Requiring accounting on loss of control that is consistent with the accounting for selling the individual net assets to a third party is an improvement; in both cases the economics of the exchange are the same, so there is no reason why the accounting should be different.

(c) The amendment aligns the accounting for loss of control with the changes in the IFRS 3R relating to remeasurement of the previously held interest when a parent achieves control of a subsidiary in a step acquisition.

23 On the other hand, the majority of EFRAG members thought it would be wrong to recognise a gain or loss in profit or loss on the retained interest when a parent loses control of a subsidiary, because an exchange transaction with a third party has not taken place.

24 Overall, all EFRAG members agree that Amendment 2 enhances comparability, but the majority of EFRAG members think the accounting it requires is not the most appropriate of the alternatives available.

Amendment 3—Accounting for losses attributable to NCI

25 A majority of EFRAG members believe that Amendment 3 will improve the information provided because it eliminates an inconsistency in existing IAS 27 by aligning the accounting for allocation of losses to NCI with the requirement to classify NCI as equity.

26 However, some members do not. In their view, the accounting for loss allocation in existing IAS 27 reflects better how the losses will be borne in practice, unless there is a contractual agreement whereby they have agreed to meet those losses.

Does the accounting that results from IAS 27A’s application meet the criteria for EU endorsement?

27 As explained above, all EFRAG members believe that IAS 27A is not inconsistent with the Framework. Having considered whether the various amendments in IAS 27A were likely to improve the information provided:

(a) the majority of EFRAG members believe that Amendment 1 will improve the quality of the information provided;

(b) all EFRAG members agree that Amendment 2 enhances comparability, but the majority of EFRAG members think the accounting it requires is not the most appropriate of the alternatives available; and

(c) a majority of EFRAG members believe that Amendment 3 will improve the information provided.


9

28 EFRAG then considered whether IAS 27A meets the requirements of the European Parliament and of the Council on the application of international accounting standards, in other words that IAS 27A:

(a) is not contrary to the ‘true and fair principle’ set out in Article 16(3) of Council Directive 83/349/EEC and Article 2(3) of Council Directive 78/660/EEC; and

(b) meets the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management.

EFRAG has also considered whether it is in the European interest to adopt IAS 27A.

Relevance

29 According to the Framework, information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations.

30 The majority of EFRAG members believe that IAS 27A will result in information that is relevant to the needs of users of financial statements, and that it will not result in relevant information being omitted from the financial statements.

Reliability

31 The existing Framework explains that information has the quality of reliability when it is free from material error and bias and can be depended upon by users to represent faithfully that which it either purports to represent or could reasonably be expected to represent.

32 EFRAG considered whether the implementation of IAS 27A would result in reliable information being included in the financial statements. The only potential concern EFRAG identified arose from the new requirement to measure the NCI retained at fair value when control is lost. However, most EFRAG members believe that in most cases the remeasurement to fair value will be made when the parent decides to sell its controlling interest in the subsidiary, and at that time most of the information required to estimate the fair value of the NCI should be available. For this reason, EFRAG concluded that reliability was not a significant concern.

Comparability

33 The notion of comparability requires that like items and events are accounted for in a consistent way through time and by different entities, and that unlike items and events should be accounted for differently.

34 The enhancements to the comparability of the information that IAS 27A achieves have already been mentioned.

(a) It introduces requirements on the accounting treatment of changes in ownership interest that do not involve a loss of control, an area where,


10

EFRAG understands, a number of different methods are being applied in practice.

(b) IAS 27A will clarify some aspects of accounting for loss of control, thereby reducing the divergence in practice and enhancing the comparability of the information provided.

(c) It aligns the accounting for transactions that result in loss of control in a subsidiary with the accounting in the revised IFRS 3 on achieving control in a subsidiary.

35 The requirement to apply the amendments prospectively will have a negative impact on comparability, but nevertheless EFRAG believes the comparability criterion will be met.

Understandability

36 Financial information provided should be readily understandable by users with a reasonable knowledge of business and economic activity and accounting and the willingness to study the information with reasonable diligence.

37 Although IAS 27A introduces some new notions and will require users to look at aspects of a set of consolidated financial statements in a different way than hitherto, the majority of EFRAG members did not have any concerns about the understandability of the information that would be provided by applying IAS 27A

True and fair

38 For the reasons set out above, the majority of EFRAG members see no reason to believe that IAS 27A is inconsistent with the true and fair view requirement.

European interest

39 EFRAG considered whether the benefits of implementing IAS 27A in the EU exceed the costs of doing so. On balance, EFRAG concluded that the benefits that are expected to arise from implementing IAS 27A in the EU will exceed the costs expected to be incurred to implement IAS 27A.

Conclusion

40 For the reasons set out above, the majority of EFRAG members have concluded that on balance IAS 27A satisfies the criteria for EU endorsement. EFRAG therefore recommends its endorsement.


11

APPENDIX 2 DISSENTING VIEW

The views of two EFRAG members who voted against recommending endorsement of IAS 27A are explained in this appendix.

Two EFRAG members (Mr Michael Starkie and Mr Carsten Zielke) believe that IAS 27A should not be endorsed for use in the European Union and therefore dissent from EFRAG's decision to recommend its endorsement. These EFRAG members have reached this conclusion because they believe aspects of IAS 27A do not meet the endorsement criteria. In particular:

Accounting for ownership interest transactions that do not involve a loss of control

1 Under IAS 27A, when a parent entity buys or sells some of its interest in its subsidiary without losing control, that transaction is treated as a transaction between equity holders in their role as equity holders. As a result, no gain or loss is recognised in profit or loss. This accounting in IAS 27A is based on an entity perspective accounting model, in which the non-controlling interest and the parent entity shareholders are treated the same way. However, Mr Michael Starkie and Mr Carsten Zielke believe that the entity perspective accounting model is flawed because the non-controlling interest do not always share in the same risks and benefits as the parent entity shareholders and as a result should not necessarily be treated the same way. The result is that information that is relevant—the gains and losses arising on ownership interest transactions that do not involve a loss of control—is obscured and, as a consequence, is not satisfactorily reported.

2 Mr Michael Starkie and Mr Carsten Zielke believe that the primary objective of financial reporting is to provide information to the shareholders of the parent entity, and in their view whilst the existing mixed entity/parent perspective does that, the entity perspective does not. In their view, it is important that the consequences of changes in ownership interest that affect the owners of the parent entity are reported in the financial statements, but the entity approach does not do that.

3 Mr Michael Starkie and Mr Carsten Zielke also believe that the acquisition of a bigger interest in the subsidiary should result in more net assets (and goodwill) being recognised, and that IAS 27A does not report this relevant information.

Accounting for ownership transactions that involve a loss of control

4 Under IAS 27A, when a parent sells some of its interest in a subsidiary and, as result, loses control of that subsidiary, the former parent recognises a gain or loss not only on the ownership interest disposed of but also on the ownership interest retained. In effect, the retained interest is remeasured at the date control is lost. Mr Michael Starkie and Mr Carsten Zielke believe this is inappropriate accounting and results in the reporting in profit or loss information that is not relevant. In their view, if the retained interest has to be remeasured at the date control is lost—and they are not convinced such a remeasurement is appropriate—any gain or loss should be recognised in equity until such time as it is disposed of.

ANNEX 4

IASB Business Combinations Phase II: Project summary, feedback and effect analysis

BUSINESS COMBINATIONS PHASE IIProject summary, feedback and effect analysis

International Accounting Standards Board

January 2008

International Accounting Standards Board

Business Combinations Phase II

Project summary, feedback and effect analysis

January 2008

© Copyright IASCF 2

This document is published by the International Accounting Standards Board (IASB), 30 Cannon Street, London EC4M 6XH, United Kingdom.

Tel: +44 (0)20 7246 6410Fax: +44 (0)20 7246 6411Email: [email protected]: www.iasb.org

The IASB, the International Accounting Standards Committee Foundation (IASCF), the authors and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this publication, whether such loss is caused by negligence or otherwise.

ISBN: 978-1-905590-58-2

Copyright © 2008 IASCF®

All rights reserved. No part of this publication may be translated, reprinted or reproduced or utilised in any form either in whole or in part or by any electronic, mechanical or other means, now known or hereafter invented, including photocopying and recording, or in any information storage and retrieval system, without prior permission in writing from the IASCF.

Copies may be obtained from the IASCF. Please address publications and copyright matters to:

IASC Foundation Publications Department, 1st Floor, 30 Cannon Street, London EC4M 6XH, United Kingdom. Tel: +44 (0)20 7332 2730 Fax: +44 (0)20 7332 2749 Email: [email protected] Web: www.iasb.org

The IASB logo/‘Hexagon Device’, ‘eIFRS’, ‘IAS’, ‘IASB’, ‘IASC’, ‘IASCF’, ‘IASs’, ‘IFRIC’, ‘IFRS’, ‘IFRSs’, ‘International Accounting Standards’, ‘International Financial Reporting Standards’ and ‘SIC’ are Trade Marks of the IASCF.

3 © Copyright IASCF

Contents page

Overview 4

Project history 7

The revised IFRS 3 and amended IAS 27 8

Feedback and effect analysis 12

Resources 45


BUSINESS COMBINATIONS PHASE II

In January 2008 we—the International Accounting Standards Board—completed the second phase of the business combinations project.

The objective of the project, which we undertook with the US Financial Accounting Standards Board (FASB), was to develop a single high quality standard of accounting for business combinations that would ensure that the accounting for M&A activity is the same whether an entity is applying IFRSs or US generally accepted accounting principles (GAAP).

The result of the project is that we have issued a revised version of IFRS 3 Business Combinations and an amended version of IAS 27 Consolidated and Separate Financial Statements. The FASB has issued SFAS 141(R) Business Combinations and SFAS 160 Noncontrolling

Interests in Consolidated Financial Statements.

Why we undertook the project

A business combination is the acquisition of one business by another, and is part of what is commonly referred to as M&A (mergers and acquisitions) activity. Business combinations are an important feature of the capital markets. In 2006 there were more than 13,000 M&A transactions worldwide.* Just under half, with a combined value of €1.03 trillion (US$1.49 trillion), were completed by entities that apply US GAAP. Most of the rest, worth about €1.26 trillion (US$1.82 trillion), were completed by entities that apply International Financial Reporting Standards (IFRSs) or are moving to IFRSs. Over the last decade the average annual value of corporate acquisitions worldwide has been the equivalent of 8–10 per cent of the total market capitalisation of listed securities.

The project was designed to unify M&A accounting across the world’s major capital markets. When we started the project we were observing rapidly accelerating movement of global capital fl ows—there has been a fi ve-fold increase in the volume of transatlantic deals between 2003 and 2006.

Investors and their advisers assess how the activities of the acquirer and its acquired business will combine, which is challenging enough when entities use the same accounting. It is more diffi cult to make comparisons when acquirers are accounting for acquisitions in different ways, whether those differences are a consequence of differences between US GAAP and IFRSs or because IFRSs or US GAAP are not being applied on a consistent basis.

* On average, about 75–80 per cent of the transactions involved public companies with the rest being private equity transactions.

Overview

Last year there were more than

13,000 M&A transactions with

a combined value of more than

€2 trillion.


PROJECT SUMMARY, FEEDBACK AND EFFECT ANALYSIS JANUARY 2008

Why the business combinations project will

lead to improved fi nancial reporting

We think the revised IFRS 3 and the amended IAS 27 will improve fi nancial reporting for those using IFRSs because:

the new versions address defi ciencies in the existing IFRS 3 and IAS 27 without changing the basic accounting; and

by rewriting IFRS 3 we have been able to unify M&A accounting across the world’s major capital markets.

The revised IFRS 3 reinforces the existing IFRS 3 model but remedies problems that have emerged in its application. The revised IFRS 3 will allow entities to choose to measure non-controlling interests using the existing IFRS 3 method or on the same basis as US GAAP.

The revised IFRS 3 is also more succinct than its predecessor, with a greater emphasis on laying out the principles for the application of the acquisition method to business combinations.

As a result of the project, the FASB has made fundamental changes to its accounting for business combinations, most of which bring US accounting into line with the existing IFRS 3 and IAS 27. Other improvements we made will change both IFRSs and US GAAP. These improvements are based on our experience with IFRS 3 and IAS 27 and the US experience with SFAS 141. We have learned from each other.

•

•

1. Only restructuring costs that the acquirer is obliged to incur are recognised2. Each asset and liability in a partial acquisition is measured at 100% of its fair value3. Gains on a bargain purchase are income4. In-process R&D is an asset5. The date of acquisition is when control is achieved6. Allowing retrospective adjustment

1. Simplified measurement of goodwill in a step acquisition2. Acquisition-related costs are expenses3. Contingent consideration recognised at the acquisition date

Revised IFRS 3US SFAS 141(R)

Initial recognition of a business combination Subsequent accounting

US SFAS 141 US ARB 51The starting point for US GAAP

IFRS 3

Non-controlling (minority) interests are part of the equity of the group

Acquisitions or disposals of non-controlling interests are

equity transactions

Amended IAS 27US SFAS 160

IAS 27The starting point for the IASB

Improvements the boards agreed together

Aligned M&A accounting requirements

Changes the FASB made to align US GAAP with IFRSs



Next steps

There are still some differences between the revised IFRS 3 and SFAS 141(R). Most of those differences are because of differences between other IFRSs and US GAAP. We have designed the revised IFRS 3 with the intention that any future work on removing those differences will not cause us to have to make major revisions to IFRS 3. Rather, our focus will be on, eventually, removing the exceptions to the principles in IFRS 3.

In December 2007 we added to our agenda a project to consider one of the exceptions—the accounting for business combinations under common control. This is an area that preparers, regulators and auditors have asked us to address.

We will continue to monitor IFRS 3 and IAS 27 (which is part of an active agenda item dealing with consolidated fi nancial statements) both informally and through the more formal process of post-implementation review.



Project history

The business combinations project became part of our initial agenda when the IASB was formed in 2001. Accounting for business combinations had been identifi ed previously as an area of signifi cant divergence within and across jurisdictions. Extensive work on the topic had been undertaken in the previous decade by national standard-setters, notably the group of national standard-setters and our predecessor, IASC, known as the G4+1.

By the time the IASB was formed, the FASB had fi nalised SFAS 141 Business Combinations, which removed the merging (or pooling) of interests method and replaced amortisation of goodwill with a goodwill impairment test. We received numerous requests from around Europe and Australia to make similar changes to the accounting for goodwill because entities applying IFRSs believed themselves to be at a disadvantage to those using US GAAP.

We decided to split the project into two phases. The fi rst phase would be short-term, addressing pooling of interests and goodwill impairment and amortisation in a replacement of IAS 22 Business Combinations. The second phase would take a broader look at business combination accounting. We started the two phases at about the same time, which meant that they ran in parallel until the fi rst phase was completed.

We worked with the FASB on the second phase. We concluded that sharing our resources and debating the issues together was the best way for each to improve the application of the acquisition method and to ensure a level playing fi eld by eliminating as many as possible of the differences between IFRS 3 and SFAS 141.

Before the fi rst phase had been completed we had already fi nished our analysis of the initial measurement of identifi able assets acquired and liabilities assumed in a business combination; the recognition of liabilities for terminating or reducing the activities of an acquiree; and the accounting for bargain purchases. We decided to incorporate those decisions in the original IFRS 3, which was issued in March 2004, bringing the fi rst phase of the project to a conclusion. The changes we incorporated in IFRS 3 moved IFRSs ahead of US GAAP.

As we explained in the basis for conclusions on the original IFRS 3, the second phase of the project would address the aspects of M&A activity for which there was no guidance. We were also examining the requirements that we had carried forward from IAS 22 into IFRS 3 without reconsideration. The continuation of our work in the second phase of the project gave both boards the opportunity to address those parts of IFRS 3 and IAS 27 (and the US equivalents) that we knew required additional work. It also provided the FASB with the opportunity to catch up with the decisions already incorporated in IFRSs.



Changes to the IFRSs

The revised IFRS 3 and amended IAS 27 incorporate many changes from the exposure drafts that we made as a result of debating the proposals in the light of comments we received during our consultations. The main changes that the revised IFRS 3 and amended IAS 27 will make to the existing requirements or practice are described below.

Step and partial acquisitions

The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating a portion of goodwill has been removed. Instead, goodwill is measured as the difference at acquisition date between the value of any investment in the business held before the acquisition, the consideration transferred and the net assets acquired.

For a business combination in which the acquirer achieves control without buying all of the equity of the acquiree, the remaining (non-controlling) equity interests are measured either at fair value or at the non-controlling interests’ proportionate share of the acquiree’s net identifi able assets. Previously, only the latter was permitted. Allowing this choice was a change from the proposal that was made in response to concerns expressed by many respondents.

Transparency and comparability

Acquisition-related costs must be accounted for separately from the business combination, which usually means that they are recognised as expenses (rather than included in goodwill).

An acquirer must recognise at the acquisition date a liability for additional consideration (contingent consideration). Changes in the value of that liability after the acquisition date are recognised in accordance with other IFRSs, as appropriate, rather than by adjusting goodwill. The disclosures required to be made in relation to contingent consideration have been enhanced.

New guidance to address diverging practice

We added requirements to specify that changes in a parent’s ownership interest in a subsidiary that do not result in the loss of control must be accounted for as equity transactions, remedying a defi ciency in the existing IAS 27.

We clarifi ed the requirements for how the acquirer accounts for some of the assets and liabilities acquired in a business combination that had been proving to be problematic—replacing the acquiree’s share-based payment awards; being indemnifi ed by the seller; rights, such as franchise rights, that the acquirer had sold to the acquiree previously and are part of the business combination; embedded derivatives; cash fl ow hedges; and operating leases.

Other improvements

We brought within the scope of IFRS 3 business combinations involving only mutual entities and business combinations achieved by contract alone. This ensures that the accounting for an important part of M&A activity for which there have been no IFRS requirements will be consistent with the accounting for other M&A activity.

The revised IFRS 3 and

amended IAS 27



We removed an inconsistency in the existing IAS 27 by requiring that an entity must attribute a share of any losses to the non-controlling interests even if this results in the non-controlling interests having a defi cit balance.

We added requirements to specify how, upon losing control of a subsidiary, an entity measures any resulting gain or loss and any investment retained in the former subsidiary.

Eliminating the differences between IFRSs and

US GAAP

The changes described above were also changes that the FASB made to US GAAP.

Changes to US GAAP

The changes made by the FASB to US GAAP are more fundamental than the changes we have made to IFRSs. Among the more signifi cant of the changes it has made, all of which bring US GAAP into line with existing IFRSs, are:

classifying non-controlling interests as equity.

requiring restructuring charges to be accounted for as they are incurred, rather than allowing these to be anticipated at the time of the business combination.

requiring in-process research and development (IPR&D) to be recognised as a separate intangible asset, rather than immediately written off as an expense.

aligning the acquisition date with the date defi ned in the existing IFRS 3 (at present US GAAP uses the agreement date).

recognising a gain on a bargain purchase in income (rather than by allocating it to some of the assets acquired).

Remaining differences

We were not able to eliminate all differences between the existing IFRS 3 and IAS 27 and their US GAAP equivalents.

Different conclusions

We reached decisions different from those reached by the FASB in relation to two matters—the measurement of non-controlling interests and three disclosure items. The revised IFRS 3 permits an acquirer to measure the non-controlling interests in an acquiree either at fair value or at their proportionate share of the acquiree’s identifi able net assets whereas SFAS 141(R) requires the non-controlling interests in an acquiree to be measured at fair value.

Legacy differences between other IFRSs and US GAAP

Other differences remain because of the boards’ decision to provide guidance for accounting for business combinations that is consistent with other IFRSs or US GAAP. Many of those differences are being considered in current projects or are candidates for future convergence projects, which is why the boards allowed those differences to continue at this time.

The boards have different defi nitions of control, because of differences between our consolidations standards. As a consequence it is possible that a transaction that is a business combination in accordance with the revised IFRS 3 might not be a business combination in accordance with SFAS 141(R). We have a separate project to replace IAS 27 and expect, as a fi rst step, to publish a discussion paper in 2008.

•

•

•

•

•

The changes made by the

FASB to US GAAP are

more fundamental than the changes we have made to

IFRSs.



The revised IFRS 3 carries forward the defi nition of fair value from the existing version, which is based on an exchange value. US GAAP defi nes fair value as an exit value. We have a separate project in which we are considering the defi nition of fair value and related measurement guidance.

The boards have very similar requirements for recognising and measuring assets and liabilities arising from contingencies, both initially and after the acquisition. However, differences between the criteria for initial recognition (IFRS 3 has a ‘reliable measurement’ threshold whereas SFAS 141(R) has a ‘more likely than not’ threshold for non-contractual liabilities) might to lead to some differences in application. We have an ongoing project to amend or replace the relevant IFRS—IAS 37 Provisions, Contingent

Liabilities and Contingent Assets.

Our consultation process

Our public consultations on business combinations have been extensive and spanned several years. The letters we received commenting on our exposure drafts were not our only source of feedback. As well as taking part in the round-table meetings, our staff and individual Board members attended and gave presentations at numerous conferences and seminars and met many individuals and representatives of organisations.

Consultations leading to the exposure drafts

Although exposure drafts are the most obvious part of our process of public consultation, our consultations on this project began much earlier. By the time we published the exposure drafts we had debated the proposals at 28 of our public Board meetings and three joint public meetings with the FASB. We also held meetings with our Standards Advisory Council (in public) and with industry groups and other interested parties to benefi t from their insight and expertise on specifi c issues, including industry-related questions. We undertook an extensive series of fi eld visits as part of the fi rst phase of the project, visiting 44 entities in seven countries.* Those fi eld visits helped inform the second phase of the project.

Because the project was conducted jointly with the FASB we were able to share staff and other resources. The FASB set up a business combinations resource group comprising accounting, auditing, analyst, valuation and related fi nancial reporting experts in business combinations. We consulted the FASB’s resource group members on various issues throughout the project and took part in meetings with them in April and August 2003. In 2004 FASB and IASB staff undertook fi eld visits to fi ve companies that had recently completed a business combination.

Exposure drafts

In June 2005 we published a joint exposure draft with the FASB to replace the original IFRS 3 and FASB Statement No. 141 Business Combinations (SFAS 141). We also published related proposed amendments to IAS 27 and the FASB published a proposed statement to replace Accounting Research Bulletin No. 51 Consolidated Financial Statements (ARB 51). The exposure drafts were open for comment for four months, ending on 28 October 2005.

Post-exposure draft consultation

In October and November 2005 we hosted, jointly with the FASB, fi ve public round-table meetings, which were held in the FASB’s offi ces (in Norwalk, Connecticut) and in London. Representatives of over 50 leading organisations from around the world participated in the discussions.

* Australia, France, Germany, Japan, South Africa, Switzerland and the United Kingdom.



Throughout 2006 and the fi rst half of 2007, we debated the issues raised by respondents to the 2005 exposure drafts and by participants in the round-table meetings. We also continued to consult the Standards Advisory Council, our Analysts Representative Group and other experts. We had 13 public decision-making meetings, plus three joint public meetings with the FASB. The FASB held a similar number of meetings, in all of which our staff took part.

The staff and Board members continued to make public presentations about the project, which gave the opportunity for those attending to provide us with additional comments and input. In addition, the project staff held many private meetings with respondents, to follow up matters raised in their comment letters.

The staff fi eld tested aspects of the proposals, to help them assess whether revisions to the exposure drafts were addressing the matters raised by respondents. This process included completing a case study in which participants were asked to account for a business combination. They were provided with a purchase agreement and other pertinent information about the businesses and were asked to identify the assets acquired and liabilities assumed and to measure them at fair value. This fi eld test involved the participants spending up to 300 hours of staff time completing the case study.

The staff also analysed fi nancial statements and M&A data, including undertaking simulations to assess the likely fi nancial reporting effect of the proposals.

Drafting

In April 2007 we instructed our staff to prepare the revisions and amendments for our formal voting procedures. Those drafts were sent to selected external technical experts for review.

Post-implementation review

The standards issued in January 2008 will be subject to a post-implementation review two years after they have become mandatory. Such reviews are limited to important issues identifi ed as contentious during the development of the pronouncement and consideration of any unexpected costs or implementation problems encountered.

We will also continue informal consultations throughout the implementation of the revised IFRS 3 and the amended IAS 27.

The standards will be subject to a

post-implementation review.



Background

Feedback

We and the FASB received comment letters on the exposure drafts of 2005 from 287 respondents.* In our deliberation process we, together with the FASB, considered the matters raised in the comment letters along with matters raised through our other consultations. The result is that the revised IFRS 3 and the amended IAS 27 are different from those proposed in the exposure drafts. Among the more notable changes were:

We decided not to proceed with the full goodwill model, which has a ‘whole of business’ emphasis. Instead, we shifted the focus back to the components of business combination transactions, being the consideration transferred and the assets, liabilities and equity instruments of the acquiree.

In response to concerns expressed by respondents, we allow preparers to choose between measuring non-controlling interests as their proportionate interest in the net identifi able assets of the acquiree (which is the requirement in the original IFRS 3) and fair value (which is the new requirement in US GAAP). This will allow preparers to select the measurement basis most appropriate to their circumstances.

In response to concerns expressed by respondents, we have added a requirement to present a schedule that will make it easier to assess the interests the parent shareholders have in the group.

We also ensured that the fi nal documents are drafted in a style familiar to the IFRS community.

The sections that follow provide a more detailed explanation of the matters raised by respondents, and how our thinking was infl uenced in developing the fi nal standards.

Effect analysis

Before we issue new requirements, or make amendments to existing IFRSs, we consider the costs and benefi ts of what we are proposing. This includes assessing the costs incurred by preparers of fi nancial statements and the costs incurred by users of fi nancial statements when information is not available. We also consider the comparative advantage that preparers have in developing information, when compared with the costs that users would incur to develop surrogate information.

One of the main objectives of developing a single set of high quality global accounting standards is to improve the allocation of capital. We therefore also consider the benefi t of better economic decision-making as a result of improved fi nancial reporting.

We expect our standards to have economic effects, and we expect those effects will be benefi cial for some entities and detrimental to others. A change in fi nancial reporting requirements might affect the cost of capital for individual entities if, for example, the fi nancial reporting requirements change the absolute or relative level of information asymmetry associated with those entities.

* About 70 of the letters were ‘form’ letters from organisations of co-operatives.

•

•

•

Feedback and effect analysis



Our evaluations of costs and benefi ts are necessarily qualitative, rather than quantitative. This is because quantifying costs and, particularly, benefi ts is inherently diffi cult. Although other standards setters undertake similar types of analysis, there is a lack of suffi ciently well-established and reliable techniques for quantifying this analysis.

Our assessment is also on the likely effect of the new requirements. The actual effects will not be known until after the new requirements have been applied. We encourage academic researchers to perform empirical research into the way information mandated by our standards is incorporated into economic decisions. These studies, which focus on the role of accounting information in the capital markets, provide us with insights into how accounting information is incorporated into share prices. Other studies focus on how changes to IFRSs affect the behaviour of parties, such as management. We expect to consider relevant research as part of our post-implementation review.

Some jurisdictions that incorporate IFRSs within their legal framework require, or elect to prepare, some form of regulatory impact assessment before a new IFRS, or an amendment to an existing IFRS, is brought into law. The requirements vary from jurisdiction to jurisdiction, and in some cases have broader policy factors in mind than the effect on preparers and users.

It is unlikely that we could prepare an assessment that meets the needs of every jurisdiction. What we can do, however, is provide jurisdictions with input to their processes. We can, for example, document what we learned during the development of an IFRS about the likely costs of implementing a new requirement and the ongoing costs. We gain insight on the costs and benefi ts of standards through our consultations, both via consultative publications (discussion papers, exposure drafts etc) and communications with interested parties (liaison activities, meetings etc).

Our expectation is that the assessment that follows will assist jurisdictions in meeting their requirements.

Assessing who bears the costs

Who bears the costs is important. For example, an acquirer might choose to measure non-controlling interests at their proportionate interest in the net identifi able assets of the acquired business, rather than at fair value. If analysts want to use the fair value of the non-controlling interests in a valuation, for example, each analyst will incur costs estimating that fair value. Allowing a lower cost option for preparers can shift the costs to analysts and other users—assuming, in this example, that the analyst prefers to measure non-controlling interests at fair value. It is also likely that the estimate of fair value made by each analyst will be less reliable than the estimate made by the acquirer. The analyst will not have access to as much information about the subsidiary. If the analyst prefers to measure non-controlling interests at their proportionate interest in the subsidiary, then requiring them to be measured at fair value imposes a cost on the preparer with no benefi t to the users.

In assessing the effect of IFRS 8 Operating Segments the Australian Accounting Standards Board stated:

There is no universally accepted methodology for quantitatively measuring costs and benefi ts of information presented in fi nancial reports. The costs of providing fi nancial information are incurred, in the main, by reporting entities, but extend in various direct and indirect ways to the users of general purpose fi nancial reports. There is no guarantee that the costs are borne ultimately by those who derive the benefi ts.*

* Australian Accounting Standards Board, Regulation Impact Statement, AASB 8 Operating Segments.



Effect on the fi nancial reports

We have assessed how the changes to IFRS 3 and IAS 27 will affect the fi nancial statements, in terms of how the elements are measured and information available to users.

Sometimes disclosure requirements will place into the public domain information prepared by the entity that users have not been able to observe directly. The user might have been estimating this information on the basis of other sources. The disclosure could, therefore, reduce information uncertainty. This can have the effect of changing the way users view the business, perhaps affecting the cost of capital. We think that changes to the disclosure or measurement requirements that reveal new information to users are appropriate because it should lead to a more effi cient allocation of resources within a capital market.

A disclosure requirement might require entities to disclose information that is helpful to their competitors. In such cases, the competitive advantage an entity enjoys could be reduced. This is a cost to the entity—sometimes referred to as proprietary costs.

It is not possible for us to assess how a change in the disclosure or measurement requirements in this IFRS will affect individual entities. Therefore, our assessment of the effect on the fi nancial statements is descriptive rather than judgemental.

Preparation costs

Preparation costs include the costs of collecting and processing information, seeking independent expertise and professional advice and auditing. Changes in the recognition or measurement requirements in an IFRS could increase or decrease preparation costs. For example, it is likely to be more costly to measure the fair value of non-controlling interests than it would be to measure the non-controlling interests’ proportional interest in the net assets of the acquired business.

Sometimes a change in the requirements of an IFRS will cause entities to change their accounting systems. In other cases the requirements have ongoing cost implications. For example, changing an IFRS in a way that aligns its requirements more closely with how management accounts for a transaction is likely to reduce ongoing costs.

If the requirements in an IFRS are not clear, or there is no guidance, the preparer will often have to seek independent advice and engage with its auditors to resolve the uncertainty about how to account for a particular type of transaction. These costs should decrease if the requirements in the revised IFRS are clearer.

Analysis costs

Analysis costs include the costs of extracting data, identifying how the data have been measured and adjusting data for the purposes of including them in, for example, a valuation model. The more work a user has to do to get the data into a form suitable for its purposes the higher the analysis costs.

Comparability

Users prefer to have information that is comparable. By comparable, we mean the ability of a user to compare information from reporting period to reporting period for an individual entity and between different entities in a particular reporting period. Comparability is, generally, achieved by having clear principles that lead to similar transactions or events being accounted for in a similar way.

Usefulness

In making our decisions we have endeavoured to identify the information requirements of those who use the information. We have assumed that users think information is useful if it helps them to assess the future cash fl ows of the entity. Comment letters and our interactions with our user advisory groups have confi rmed that this is an appropriate basis for making this assessment.



Relative costs and benefi ts

In assessing the effect of the revised IFRS 3 and the amended IAS 27 our main focus has been on the likely costs and benefi ts of the new requirements relative to the requirements they are replacing.

We have taken this approach for two reasons. First, it is inherently diffi cult to measure costs and benefi ts in absolute terms. Business combinations can vary signifi cantly in size and complexity and how the changes we have made to the accounting will affect a particular entity or user can also vary to the same extent. It would not be meaningful to try to assess the average effect. Second, the project is revising the accounting for business combinations. Because we have requirements in place we think that it is appropriate to focus on the likely effect of a change rather than its absolute effect.

Assessment of the likely effect

For each of the revisions to the original IFRS 3 and the amendments to IAS 27 we assessed the likely effect on preparers and users. The sections that follow provide our assessment of the more signifi cant revisions. For example, a decrease (increase) in preparation costs is described as having a positive (negative) effect.

In some cases there might be no effect, or we assess the effect as being small. For example, if analysts are reviewing the statement of comprehensive income and making their own adjustments to the reported amounts, we have assessed the cost of making an additional adjustment as being small if the information is disclosed. In such cases we assess the changes as being neutral.

General comments from respondents

Some respondents expressed surprise that the proposed revision of IFRS 3 was so different from the existing version. Those respondents appear not to have been expecting a major rewrite of IFRS 3, particularly so soon after the IFRS had been issued. Some respondents thought the documents were too long and detailed.

We think that this reaction is partly attributable to the style of the exposure draft and to the inclusion of illustrative examples in the application guidance. The drafting changes gave a false impression that the changes to the requirements were also extensive.

Rather than try to piece together a blend of IFRS 3 and SFAS 141 we had decided that a new common standard should be drafted. As a result, the drafting differences between the proposed and existing IFRS 3 were far more extensive than the technical differences. And it did not help that the proposed revision to IFRS 3 was published only 15 months after the original IFRS 3 was issued.

It was also clear that many respondents do not welcome change. We observed that any change from current practice was more likely to be criticised than retaining current practice. For example, many respondents applying US GAAP objected to the changes to US GAAP being proposed in relation to the classifi cation of non-controlling interests, restructuring charges, IPR&D, bargain purchases and the acquisition date. Yet few IFRS respondents commented on those matters because they were not changes to existing IFRS requirements.

Not all the responses were negative. Some respondents welcomed the additional guidance we proposed for the initial recognition of leases and identifi cation of what is part of a business combination. Many respondents supported the elimination of differences between IFRSs and US GAAP.



Initial measurement of goodwill and

non-controlling interests

Full goodwill

The focus of changes in M&A accounting standards over the last twenty years has been to provide better guidance on identifying what the acquirer is paying for and how to measure those items. However, the most diffi cult area is acquisitions in which the acquirer gains control of the business but does not buy all of the shares (or equity) of the business. In those cases there will be others who are also shareholders in the business (minority or non-controlling equity interests).

The model that underpins the existing version of IFRS 3 is that because the acquirer has control of a business it recognises 100 per cent of each asset and liability, even if it does not own 100 per cent of the shares. The rationale is that by controlling a business an entity is able to control each of the assets and liabilities. IFRS 3 already requires each of those assets and liabilities to be measured at fair value at the date the acquirer gains control. In contrast, US GAAP requires each asset to be measured partly on the basis of fair value and partly on the basis of its carrying amount before the business was acquired. The FASB is changing to the original IFRS 3 model.

Goodwill is the one exception to this basic approach. Even though the acquirer controls the whole business, few accounting standards have required all of the goodwill to be recognised. The common practice has been to recognise only the acquirer’s proportionate interest in the goodwill. This is the approach in the original IFRS 3.

In the exposure draft we proposed that the acquirer should be required to treat goodwill like other assets. That would mean that all of the goodwill would be recognised, rather than just the proportion attributable to the controlling party. To implement that principle the exposure draft suggested a different emphasis for accounting for a business combination. The idea was that the acquirer should start by measuring the fair value of the business as a whole. The goodwill could then be derived by measuring the difference between the fair value of the business and the sum of the net assets acquired and liabilities assumed. This approach is commonly referred to as the full goodwill method because it focuses on measuring the full value of the goodwill.

Respondents’ comments—full goodwill

The proposal was not well received. Many respondents stated that the proposal placed too much emphasis on estimating the fair value of the business and that this estimate can be unreliable. Some respondents did not believe that goodwill is an asset and others believed that the full goodwill approach is inconsistent with their view that the fi nancial statements should focus on the parent’s shareholders.

Our response—a change in focus

In response to the concerns raised by respondents, and in the light of our own analysis, we decided not to continue with a focus on the fair value of the business as a whole or, as a consequence, the full goodwill method. Instead, we shifted the focus back to the components of business combination transactions, being the consideration transferred and the assets, liabilities and equity instruments of the acquiree. Any difference between the consideration transferred and the components of the business would be attributed to goodwill (or a gain on a bargain purchase). This is the same approach as that in the existing IFRS 3.



Step acquisitions

The exposure draft proposed simplifying the accounting for goodwill in a step acquisition (ie an acquisition in which an entity obtains control of a business in two or more steps). The original IFRS 3 required entities to measure the fair value of each asset and liability at each step for the purposes of measuring the portion of goodwill attributable to that step. The exposure draft proposed that the measurement of goodwill should be calculated as a residual on the basis of the fair values of the assets and liabilities at the acquisition date. The exposure draft also proposed that any interest in the investment held immediately before the acquisition should be measured at fair value and any related gain or loss recognised in profi t or loss.

Respondents’ comments

Most respondents supported the change to the measurement of goodwill.

Our response

The revised IFRS 3 incorporates the change proposed.


Some respondents agreed that the previously held investment should be measured at fair value before being recognised but believed that the gain or loss from the initial measurement of the retained investment should not be recognised in profi t or loss. They argued that, by analogy with available-for-sale fi nancial assets, the gain or loss should be recognised in other comprehensive income.

Our response

We considered requiring any gain or loss to be reported as other comprehensive income. However, achieving control of an entity causes the group to derecognise the previously held investment. Recognising any related gain or loss in other comprehensive income would be inconsistent with the accounting for the derecognition of other assets.

Financial statement effect

The acquirer might recognise a gain or loss associated with any differences between the fair value of previously held interests and their carrying amounts. It is more likely that the acquirer will recognise a gain than a loss because of the impairment requirements in IFRSs.

... we decided not to continue with a focus on the fair value of the business as a whole or, as a

consequence, the full goodwill

method.



Cost and benefi t assessment

Preparers

Assessment Effect Analysis

Signifi cantly reduced preparation costs

Positive Preparation costs should be reduced signifi cantly. This is because applying the original IFRS 3 to a step acquisition requires every asset and liability to be measured at fair value when each step is taken. The new requirements eliminate this requirement for all steps before the acquisition date.

The acquirer must measure the fair value of any interest held before obtaining control. That requires one additional valuation, at a time when the acquirer is measuring all of the assets. The more steps the acquirer has taken, the more signifi cant the reduction in preparation costs.

Users


Minimal effect on analysis costs

Neutral Users tell us that if they are using an earnings-based model to value the entity they will adjust any gain or loss associated with the previously held interest out of reported earnings.

We are told that the marginal cost of making that adjustment is low because analysts and investors are already reviewing the fi nancial statements and making other adjustments.

Increased comparability

Positive Goodwill will be measured on the same basis, rather than as an accumulation of past costs.

Recognising the gain or loss on derecognition of the previously held investment ensures consistency with the derecognition of investments by other means.

Increased usefulness

Positive Goodwill will represent the additional amount the acquirer has paid over the value of the net identifi able assets of the business to gain a controlling interest at the date control was achieved. Previously, goodwill was an accumulation of cost differences at each step.

Non-controlling interests

Our decision not to continue with a full goodwill model did not allow us to avoid the problem of how to measure non-controlling interests. A non-controlling interest is a component of equity in the acquirer’s consolidated fi nancial statements. We concluded that the usefulness of information about a non-controlling interest would be improved if the revised standards specifi ed a basis for measuring non-controlling interests that provides information to investors.

Our consultations with groups of those who use fi nancial statements for making (or making recommendations about) investment decisions suggested that information about the acquisition-date fair value of a non-controlling interest would be helpful in estimating the value of shares of the parent company, not only at the acquisition date but also at future dates. The fair value helps users to estimate the amount the acquirer



would need to pay to acquire the remaining non-controlling interests. Measuring non-controlling interests at their acquisition-date fair value is also consistent with the way in which other components of equity are measured.

Respondents’ comments—concerns about measuring non-controlling interests

Our discussions with respondents indicated that the change in focus from assessing the value of the business as a whole to assessing the values of the components of the business did not alleviate all of their concerns. They were particularly worried about how to measure the fair value of the non-controlling interests and the cost of doing so.

Our response—we are allowing a choice of measurement

After an extended debate we decided to allow an acquirer to choose between the two methods of measuring non-controlling interests by using the method required by the original IFRS 3, or measuring at fair value. US GAAP will require non-controlling interests to be measured at fair value.

Introducing a choice of measurement basis for non-controlling interests was not our fi rst preference. In general, we think that alternative accounting methods reduce the comparability of fi nancial statements. However, we were not able to agree on a single measurement basis for non-controlling interests because neither of the alternatives considered (fair value and proportionate share of the acquiree’s identifi able net assets) was supported by enough Board members to enable a revised standard to be issued.

We decided to permit a choice of measurement basis for non-controlling interests because we concluded that the benefi ts of the other improvements to, and the convergence of, the accounting for business combinations developed in this project outweigh the disadvantages of allowing this particular option. We plan to include an assessment of the option in the post-implementation review of the revised IFRS 3.


Reported goodwill and non-controlling interests will, normally, be higher if the acquirer elects to measure non-controlling interests at fair value.

Entities that elect to measure non-controlling interests at fair value will be revealing more information about the value of those interests than entities that measure them at their proportionate interest in the net identifi able assets.


Preparers


The effect on preparation costs will vary

Neutral Entities that elect to measure non-controlling interests at fair value will incur higher preparation costs (through the use of independent expertise and audit costs) than entities that measure them at a proportionate interest in the net identifi able assets.

Entities measuring non-controlling interests at their proportionate interest in the net identifi able assets have higher ongoing costs associated with administering impairment assessments.



We have assessed this as being neutral because entities have discretion whether to incur the costs or use the alternative measurement basis.

Users


The nature of the costs of analysis will change and depend on how entities measure non-controlling interests

Neutral There are two competing factors. On the one hand, a choice of measurement usually forces analysts to make adjustments to standardise the information, which is costly. On the other hand, many analysts value the whole entity and then deduct their estimate of the fair value of the non-controlling interests to get to the value of the parent’s shares. The cost of making that estimate is likely to be reduced for entities that elect to measure non-controlling interests at fair value. It is on that basis that we assess the effect on costs as being neutral.

There is a reduction in comparability

Negative Allowing a choice reduces comparability for two items—goodwill and non-controlling interests. The mitigating factor is that it is relatively easy to calculate non-controlling interests as a portion of identifi able net assets and, therefore, get to a common measurement base (it is not as easy to adjust the other way and would be costly to do so).

Usefulness Neutral Users tell us that information about the acquisition-date fair value of non-controlling interests would be helpful in estimating the value of shares of the parent, not only at the acquisition date but also at future dates. For those entities choosing to measure non-controlling interests in this way we assess that users will have more useful information. However, we have assessed the effect as being neutral because measuring non-controlling interests at fair value is an option.

Changes in the relative proportion of the

controlling and non-controlling interests

After a parent has control of a business (subsidiary) the parent might increase its holding by buying additional shares from the non-controlling interests, or reduce its holding by selling some shares. A parent’s relative interest in a subsidiary will also change if the subsidiary issues shares to a party other than the parent. IAS 27 did not deal with accounting for any of these transactions. At least six methods were being applied in practice.

The controlling and non-controlling shareholders are all equity holders. The exposure draft proposed that transactions between these equity holders should be accounted for on the same basis as any other transaction between equity holders—within equity. Not only is this one of the simplest of the six methods but, more importantly, it is the only method that leads to the appropriate reporting of income and equity. All of the other methods cause problems with how one or more of the components in the statement of fi nancial position or statement of comprehensive income are measured.

Respondents’ comments—little agreement on the preferred accounting

Few disagreed with the need to address the shortcomings in IAS 27 with regard to accounting for changes in non-controlling interests. However, respondents’ views on the preferred approach were as diverse as the practice that had developed.



Our response—we retained our proposals

We decided to retain the accounting proposed in the exposure draft. We rejected the alternative approaches, which lead to assets being stated at inconsistent values or income being counted twice, as unacceptable.

The business combinations project page on our Website includes some examples illustrating why we have concluded that the accounting in the amended IAS 27 provides the most useful information about these transactions.*

Respondents’ comments—non-controlling interests are a special class of equity and the fi nancial statements should focus on the shareholders in the parent

Although most respondents agreed that non-controlling interests are not a liability, some stated that non-controlling interests are a special class of equity that should be treated differently from the equity of the owners of the parent. They noted that non-controlling interests represent equity claims that are restricted to particular subsidiaries, whereas the controlling interests are affected by the performance of the entire group. Therefore, non-controlling interests bear risks and benefi t from the rights of the group to a degree different from owners of the parent entity.

Many respondents perceived that by accounting for the purchase, or creation, of non-controlling interests as a transaction within equity we were moving towards an accounting model that focuses on the reporting entity to the detriment of the parent’s shareholders. Those respondents believe that such a move hinders the ability of a user to assess the fi nancial position and performance of an entity from the perspective of the owners of the parent. Those respondents stated that:

the primary purpose of consolidated fi nancial statements is to provide useful information for the principal users of consolidated fi nancial statements—ie the owners (current and potential) of the parent entity.

non-controlling interests have information needs that are different from those of controlling interests. The information needs of non-controlling interests are best served by the fi nancial statements of the entity in which they have an interest.

the parent entity perspective provides the most relevant information for users of consolidated fi nancial statements. Owners of a parent entity are interested in information about the fi nancial performance and position of the group from the parent’s perspective to evaluate the stewardship of the entity’s management and the return on the entity’s invested capital.

Our response

We agree (and have always done so) with those respondents who commented that the owners of the parent are important users of the consolidated fi nancial statements and that the effects of transactions between the parent and the non-controlling interests should be clear. But we do not agree that the accounting we proposed obscures the fi nancial performance of the parent.

Our Framework includes defi nitions of liabilities and equity. On the basis of those defi nitions, we concluded in our 2003 revision of IAS 27 that non-controlling interests are a separate component of equity. The amendments to IAS 27 refl ect the consequences of that classifi cation. We therefore decided to retain the basic proposals in the exposure draft.

* See the resources section at the end of this document for information about how to access the site.

•

•

•



Notwithstanding that the accounting is consistent with the Framework we decided to improve the disclosures by requiring entities to present a separate schedule showing the effects on the equity of the parent entity of transactions with the non-controlling interests.

We also know that the concerns of some respondents are more fundamental than disclosure and stem from their belief that we should adopt a parent perspective in business combination accounting and consolidations more generally. The accounting for changes in non-controlling interests is consistent with our Framework. Therefore, we did not comprehensively debate the economic entity and parent entity perspectives as part of our business combinations project. We will, however, consider these matters in the proposed discussion paper on consolidations and, possibly, a forthcoming discussion paper on the conceptual framework.

Respondents’ comments—equity might be destroyed by these requirements

Some respondents disagreed with the proposed accounting because they were concerned about the effect on reported equity of the subsequent acquisition of non-controlling interests by the parent. Those respondents seemed to be particularly concerned about the effect on the reported leverage of an entity that acquires non-controlling interests and whether this might, for example, cause those entities to have to renegotiate loan agreements.

Our response

We analysed the reported equity of the 600 largest listed entities in Europe at 31 March 2007. Our analysis suggests that the concerns expressed by respondents about the possible widespread, and substantial, erosion of equity as a consequence of buying the non-controlling interest are not supported by the data we observed.

We stress, however, that even if we had concluded that there was a high probability that the accounting we were proposing was likely to cause equity to be reduced signifi cantly we would not have made a different decision about the accounting. We know that the proposed accounting for subsequent acquisitions of non-controlling interests results in a reduction in equity. All acquisitions of an entity’s own equity result in a reduction of that entity’s reported equity. Even a simple cash dividend increases the leverage of an entity. Therefore, it should not have been surprising to respondents that acquiring non-controlling interests would also affect the leverage of an entity. Such an outcome is a fair representation of the fact that resources have been transferred outside the group and the equity has been reduced.

If acquiring non-controlling interests causes the equity of a group to decrease to a very low level, or even become negative, the underlying reason for that outcome will have been a difference between the carrying amount of the equity being acquired and the amount paid.


Because many different methods are being used by entities presently applying IFRSs, it is diffi cult to assess the effect on the fi nancial statements. The most likely effect will be that goodwill and equity will be lower in the case of an acquisition. For a disposal, some entities will no longer be able to recognise a gain.

The new disclosure requirements are likely to increase the amount of information revealed about transactions between controlling and non-controlling interests.



Many respondents were concerned about the effect on reported equity of the accounting for acquisitions of non-controlling interests. Although we remain confi dent that the accounting is robust, we did some empirical analysis to assess the concerns of these respondents.

We assessed the 600 companies in the Dow Jones STOXX 600.* As a fi rst step we assessed the relative level of non-controlling interests to total equity (which includes the non-controlling interests). The basic statistics are reported in the table below.

The data reveal that 26 per cent of the STOXX companies do not have non-controlling interests. A further 25 per cent of the STOXX companies have non-controlling interests equivalent to less than 1 per cent of equity. Hence, approximately 50 per cent of the IFRS entities examined have non-controlling interests of less than 1 per cent of equity.

We analysed the fi nancial statements of the 22 companies with the largest percentage of non-controlling interests relative to total equity, to get a better understanding of the reasons why their non-controlling interests were a relatively higher portion of total equity than other entities. The two main reasons for non-controlling interests constituting a high proportion of total equity appear to be:

underperformance of those parts of the group in which there are no non-controlling interests; and

the investment strategy of the parent entity—entities that fund a lot of their operations using non-controlling equity providers.

The observed proportion of non-controlling interests as a percentage of equity is lower than the comment letters suggested. That said, the data we used are for the largest Europe-based IFRS entities. It is possible that smaller entities have relatively more, or less, non-controlling interests. We are also told that many countries that have reduced the degree of public ownership in their economies to become more reliant on private capital tend to have companies with high proportions of non-controlling interests. We do not have data to be able to assess these factors.

We also performed further simulations based on the data of those 22 companies as if the non-controlling interests were acquired. These are the companies for which acquiring non-controlling interests should have the largest effect on equity.

For each of the 22 companies we collected market capitalisation data and calculated the market-to-book ratio. The reported non-controlling interests was then multiplied by this ratio to give a proxy for the fair value of the non-controlling interests. Using the ratio in this way assumes that the market-to-book ratio is the same for all segments of the group, including those segments in which there are non-controlling interests. The actual multiple is unlikely to be the same, and the resulting measure is not likely

* The Dow Jones STOXX 600 Index represents large, mid and small capitalisation companies across 18 European countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

•

•

Reported non-controlling interests as a percentage

of total equity

Number of observations 600

Mean 4.3%

Mode 0.0%

20th percentile 0.0%


Median 0.8%





to be the same as the fair value of the non-controlling interests. Nevertheless we think that using the market to book ratio for the controlling interest as the ratio of non-controlling interests market to book is suffi cient for the purposes of our analysis.

We then assumed that the parent acquired all of the non-controlling interests, paying out an amount equal to our fair value proxy. The result is a hypothetical measure of what the reported equity might be if all of the non-controlling interests were acquired by the parent.

As would be expected, equity was reduced in all cases. This is neither a surprise nor a concern. Acquiring non-controlling interests should reduce the reported equity of a group—because assets are transferred out of the entity to the non-controlling interests holders (for example, cash paid to acquire the shares). This is the outcome we expect for any transaction with owners. A cash dividend has the same effect on leverage as acquiring non-controlling interests.

Our analysis also tells us that concerns about the possible widespread, and signifi cant, erosion of equity as a consequence of buying out the non-controlling interests are not supported by the data. We do know that some companies would report signifi cantly lower, or negative, equity if they bought out all of their non-controlling interests. However, those entities will have chosen to change the way they are fi nanced. The parent is acquiring the right to receive the share of the returns from the assets and liabilities previously allocated to the non-controlling interests. The parent already controls the net assets but does not have rights to all of the returns of those assets. The parent is not investing in more assets, it is securing the rights to the returns from the assets it already controls and it is presently sharing with the non-controlling interests.

Many entities choose to buy out the other shareholders even if doing so reduces reported equity. One of the entities we looked at reported non-controlling interests equal to 75 per cent of total equity. It also reported total equity (including non-controlling interests) as a proportion of total assets of 7 per cent, compared with an industry average of 45 per cent. The main reason for the relatively low level of total equity appears to be that the entity held treasury shares at the year-end equal to 22.6 times the carrying amount of reported equity. The ability to reacquire such a signifi cant portion of its own shares is a sign of fi nancial strength of the company, yet the effect is that reported equity is reduced.


Preparers


Reduced preparation costs

Positive Preparation costs should be reduced. This is an area in which IAS 27 did not provide any guidance. We are told that preparers incur costs seeking professional advice on how to account for these transactions. The cost of calculating the information for the method we are requiring is low, relative to the alternative methods—it does not require any fair value measurements of assets or liabilities.



Users


Reduced analysis costs

Positive Costs of analysis are likely to be reduced for two reasons. First, the accounting will be consistent, which should reduce the costs of standardising the information. Second, most analysts adjust earnings for any gains reported on disposals of non-controlling interests. That adjustment will no longer be necessary.

Comparability Positive The comparability of the information should improve signifi cantly.

Usefulness Positive The improved comparability and the application of what we think is the correct accounting should result in signifi cant improvements in the usefulness of the information about acquisitions and disposals of non-controlling interests.

Fair value

The exposure draft included a requirement to measure the fair value of the business as a whole for the purposes of calculating goodwill. That requirement would not have increased the number of assets or liabilities measured at fair value, although the requirement to measure the fair value of the business would have been new.

Respondents’ comments—too much fair value

Many respondents expressed a concern that the proposals would lead to a signifi cant increase in the use of fair value measurement.

Our response

As has been explained already, we decided not to proceed with the full goodwill method and, accordingly, there will no longer be a requirement to fair value the business as a whole.

The requirement to measure at fair value each asset acquired and liability assumed in a business combination was in IAS 22, which was issued in 1983. Hence, the principle of measuring the components of a business at fair value, which was maintained in the original IFRS 3, is not new.

We understand why respondents might have perceived that the proposals included more use of fair value, given the focus in the exposure draft on the fair value of the business as a whole.

The changes to the fair value requirements will affect only contingent consideration arrangements and step acquisitions. Whether an entity will need to make additional, or fewer, fair value measurements will depend on the circumstances of the acquisition, as the examples that follow illustrate.

For those business combinations in which the acquirer purchases all of the shares in a business in one transaction, and does not enter into any contingent consideration agreements, the fair value requirements in the revised IFRS 3 will be the same as those in the version it is replacing. This is the most common type of business combination.

For those business combinations in which the acquirer achieves control by acquiring shares in steps the revised IFRS 3 is likely to reduce the fair value measurement requirements. This is because, despite being required to measure

The requirement to measure at fair value each asset

acquired and liability assumed

in a business combination was in IAS 22, which was

issued in 1983.



at fair value the investment held immediately before achieving control, the acquirer will not have to measure the fair value of each asset and liability at each step. The greater the number of steps the acquirer takes before achieving control the more signifi cant the relief provided by the revised IFRS 3.

For partial acquisitions, in which the acquirer does not own all of the equity of a business but controls the business, the revised IFRS 3 will not change the fair value requirements. The acquirer might elect to measure non-controlling interests at fair value, but this is not a requirement.

Other improvements to IFRS 3

Acquisition-related costs

The original IFRS 3 required fees paid in relation to a business acquisition to be included in the cost of the acquisition. The result is that they were measured as part of goodwill. These costs are not an asset, yet they could remain in the statement of fi nancial position indefi nitely.

The new requirement, which is what we proposed in the exposure draft, is that fees paid for professional services in relation to a business combination will generally have to be recognised as an expense at the time of the acquisition, and the amount disclosed. This will also be a change for US GAAP, which had the same requirements as the original IFRS 3.

Feedback on the proposal was mixed. Some preparers appeared to be unhappy about the effect on earnings of recognising those costs as an expense. Analysts tell us that they generally treat those costs as a ‘one-off’ and therefore make adjustments for items such as this if they use earnings as the basis of their valuation of a business.

Respondents’ comments—recognising acquisition costs as an expense is a result of moving to a fair value model

Some respondents disagreed with the proposal because they think that recognising acquisition-related costs as expenses is a consequence of moving to a fair value model. They argued that other IFRSs require assets to be measured initially at cost and that this approach should be retained in the revised IFRS 3.

Our response

We disagree with these respondents. We have IFRSs that defi ne the elements of cost for the purposes of initial recognition. Excluding acquisition-related costs from the cost of an asset is valid in a cost accumulation model. Put simply, the Board does not accept that fees paid in relation to an acquisition are an asset or part of an asset.

Respondents’ comments—recognising acquisition costs as an expense is inconsistent with other IFRSs

Some respondents agreed with the proposal but would have preferred us to address matters that affect several standards, such as transaction and acquisition costs, more broadly rather than to amend each standard as it becomes part of an active project. Others disagreed with the proposal because they believed it will introduce new inconsistencies with how we measure assets in accordance with other IFRSs, particularly IAS 16 Property, Plant and Equipment.

Our response—we retained our proposals

We know that there are some inconsistencies in how our standards measure assets and liabilities. Some items include transaction costs and others exclude



transaction costs on initial, and sometimes subsequent, recognition. We considered whether we should amend other standards, such as IAS 16 and IFRS 5 Non-current Assets Held for Sale and Discontinued Operations but decided that it would not be appropriate to do so without separately exposing such a proposal. Nevertheless, we see merit in considering smaller issues that affect many IFRSs, and will keep this in mind when we consider future projects.

Having said that, we disagree with those respondents who think that we are creating a new problem. The original IFRS 3 required assets to be measured at fair value, not fair value plus transaction or acquisition costs. The revised IFRS 3 does not change how those individual assets should be measured. We are now requiring those costs to be recognised as expenses rather than included in goodwill.

Respondents’ comments—inability to assess return on assets

Some respondents believed that recognising acquisition costs as expenses would make it impossible to assess the return on the total investment in the new subsidiary. They argued that the acquisition costs need to be included in goodwill to ensure that the total outlay is refl ected in the statement of fi nancial position.

Our response—we disagree

This argument implies that the initial investment is in some way ‘preserved’ in the statement of fi nancial position. This is not the case now, or under any business combinations standard we know. A group will start depreciating assets, selling inventory etc as soon as the new subsidiary becomes part of the group. This means that the initial ‘investment’ amount changes as soon as the parent takes control of the new subsidiary.

Entities will be recognising through income the expenses associated with acquiring a business. It is the (net) assets that will generate returns for the acquirer. Those returns will have to be enough to recover the costs related to the acquisition.

A user can identify the total outlay in the year the acquisition takes place by looking at the information that IFRS 3 (original and revised) requires entities to disclose.


The acquirer is likely to recognise a lower profi t in the year of an acquisition than it would by applying the original IFRS 3. The difference is likely to average around 1½ per cent of the total acquisition cost.




Preparers


Preparation costs

Neutral There is no change in preparation costs.

Users


Analysis costs Neutral Users tell us that if they are using an earnings-based model to value the entity they will adjust these costs out of earnings.

We are told that the marginal cost of making that adjustment is low because analysts and investors are already reviewing the fi nancial statements and making other adjustments.

Comparability Neutral There is no effect on the comparability of the information because the accounting for acquisition costs appears to be consistent.

Usefulness Neutral Some users tell us that they prefer these costs to be recognised as an expense and disclosed. They think that this is preferable to including these costs in goodwill. Others tell us they are indifferent because they do not pay much attention to either goodwill or acquisition costs.

Contingent consideration

As part of a business combination arrangement, an acquirer might agree to make an additional payment to the former owners of an acquiree (or have the right to a refund) depending on a particular outcome. For example, the acquirer might agree to pay more if specifi ed sales or profi t targets are met, or a seller might agree to refund some of the purchase price if the acquiree breaches a regulation before the acquisition date. These arrangements are commonly referred to as contingent consideration.

The original IFRS 3 required contingent consideration to be included in the cost of a business combination at the acquisition date, but only if the additional payment or refund is probable and can be measured reliably. Subsequent changes in the estimate of the amount of contingent consideration are accounted for as adjustments to the cost of the business combination and thus affect the amount of goodwill recognised. There are no specifi c disclosure requirements related to contingent consideration, in relation to either the initial agreement or subsequent payments.

We concluded that the delayed recognition of this part of the consideration is unacceptable. The acquirer has entered into an agreement obliging it make additional payments and this is part of the consideration exchanged at the acquisition date. The existing requirements fail to represent fairly the consideration exchanged at the acquisition date.

We proposed that the acquirer should be required to recognise the obligation to make additional payments as part of the business combination. That liability should be recognised at its fair value at the acquisition date. After the acquisition date the acquirer would account for changes in the fair value of the liability in accordance with other applicable standards (which will usually require changes in the fair value



to be recognised in income). We also proposed requiring the acquirer to disclose the maximum potential amount of future payments under a contingent consideration agreement.

Respondents’ views were mixed. Although the majority of respondents did not support the proposals, a signifi cant minority did. There was more support for requiring a liability to be recognised at the acquisition date than there was for the subsequent accounting.

Respondents’ comments—reliability

Respondents who disagreed with the requirement to recognise a liability, measured at its fair value, as part of the business combination argued that doing so would fail to provide users of fi nancial statements with information about the ultimate settlement amount of that obligation. Many respondents were also concerned that it might not be possible to measure the acquisition-date fair value of contingent consideration reliably. They emphasised that some contingent consideration arrangements are a consequence of the inability of the acquirer and the seller of the acquiree to agree on the fair value of the acquiree. They argued that the lack of agreement means that it would not be possible to measure the fair value of any additional payment reliably.

Our response

The total consideration transferred will include any adjustments made as a result of contingent consideration. The principle is that the consideration should be recognised at fair value.

We think that it is inappropriate to allow an acquirer to keep this liability off the statement of fi nancial position because of a difference in expectations.

When we published the exposure draft we thought that it is more informative to recognise the fair value of the liability and supplement this with a requirement to disclose the maximum potential amount of future payments under a contingent consideration agreement. The revised IFRS 3 now requires an estimate of the range of outcomes of contingent consideration to be disclosed.

We know that measuring the fair value of some contingent consideration can be diffi cult, but delaying the recognition of some assets acquired or liabilities incurred in a business combination would cause the acquirer’s fi nancial statements to be incomplete and diminish the usefulness of the information provided.

Respondents’ comments—subsequent accounting

Most respondents disagreed with the subsequent accounting for contingent consideration. Many of those respondents stated that changes in the fair value of the liability confi rm the acquisition-date fair value of the acquiree. They argue, therefore, that goodwill should be adjusted by the change in the fair value because it is an adjustment to the purchase price for the acquiree.

Our response

We think that this description of contingent consideration is an oversimplifi cation. Many contingent consideration agreements are motivated by a wish to share some of the future performance risk. Rather than refl ecting valuation uncertainty at the date of the acquisition, the deferred settlement might be designed to share future outcomes. If the business does not perform as expected there will be an adjustment to the deferred settlement, perhaps through a profi t-sharing arrangement.

By obtaining control of the business, the acquirer has the ability to infl uence its performance. In many cases the changes in the fair value of consideration relate to post-combination events and changes in circumstances related to the combined



entity. In such circumstances, subsequent changes in the fair value of contingent consideration should be refl ected in the combined entity’s fi nancial performance. They are not related to the acquisition-date value of assets acquired or liabilities assumed in the business combination.

This accounting effect is the consequence of entering into a contingent consideration agreement related to the occurrence or non-occurrence of future events. Some contingent consideration arrangements that are recognised as a liability will have characteristics similar to those of a derivative. The subsequent measurement of contingent consideration is consistent with the subsequent accounting for derivatives in accordance with IAS 39.

Also, a change in the fair value of contingent consideration will often be offset by a corresponding change in the value of specifi c assets or liabilities to which the contingent consideration agreement relates. For example, the acquirer might have agreed to the payment of additional consideration upon favourable settlement of a legal action in which the acquiree is involved. If, after the acquisition date, a favourable settlement is obtained, two effects occur. First, the acquiree recognises a gain from the release of the liability for the legal action. Second, the acquirer recognises a loss from the increase in the fair value of contingent consideration.

Respondents’ comments—incentives to manipulate results

Some respondents argued that the proposed subsequent accounting for contingent consideration would generate counter-intuitive results because the acquirer would recognise a gain from a decrease in contingent consideration caused by a deterioration of the fi nancial condition of the acquiree. Some respondents thought that this also created incentives for an acquirer to overstate contingent consideration at the acquisition date because any subsequent decrease in fair value would be recognised as a gain in the acquirer’s statement of comprehensive income.

Our response

We know that those incentives might exist. However, we think that the accounting principle should not be compromised because of concerns about accounting abuse.

It is intuitive, for such arrangements, that a poorer than expected performance of the acquired business is shared with the previous owners through a reduction in the additional consideration payable. By specifying the basis for how the liability has been measured the acquirer will also be stating its expectations about the performance of the acquiree. Presumably, the acquirer will need to explain to users why that expectation has not been met. In some circumstances, the poorer than expected performance could lead to an impairment expense being recognised.

We are aware that the majority of respondents disagreed with the revised accounting treatment for contingent consideration after the acquisition. Thus, we will monitor the application of the revised standard and include this aspect of IFRS 3 in the post-implementation review.


Entities will be revealing more information about these types of arrangements than was required by the original IFRS 3.

At the date of acquisition, some acquirers will recognise a liability for contingent consideration that would not have been recognised by applying the original IFRS 3. That amount would also be refl ected in a higher acquisition date measure of goodwill.



After the acquisition date, any change in the fair value (or difference upon settlement) will be reported in the statement of comprehensive income. Applying the original IFRS 3 would generally see any additional payment added to goodwill and there would have been nothing recognised in the statement of comprehensive income.

If the amount, if any, paid to settle the contingent consideration liability is equal to the initial fair value, the accounting outcome would be the same by applying either the revised or the existing IFRS 3.


Preparers


Increased preparation costs

Negative It is likely that signifi cantly more contingent consideration arrangements will be recognised at the date of acquisition, which will require new fair value measures. There are ongoing requirements to measure any liability at each reporting date until the liability is settled.

Users



Positive Analysis costs are likely to be lower as a result of the change, mainly because of the increased disclosure requirements. It will also be easier to monitor the settlement of these arrangements.

Comparability Positive The information should be more comparable because all contingent consideration arrangements will be accounted for in the same way.

Usefulness Positive We made the decision to change the accounting for contingent consideration because we think the resulting information provides a better measure of the consideration for which the acquirer is liable. It also ensures that the accounting for the business combination is more complete at the acquisition date. On this basis we think the accounting will improve the usefulness of the fi nancial statements.

Users, however, have told us that they are concerned that acquirers will have an incentive to overstate the liability. By doing so the acquirer is able to recognise a gain associated with a reduced obligation if the combined entity does not perform as well as expected. Therefore, the users are more sceptical about whether the information will be more useful.

Despite the scepticism of some users, we have assessed the effect on usefulness as positive because of the improved accountability and enhanced disclosure.

Extending the scope to include mutual organisations

A mutual entity is an entity other than an investor-owned entity that provides dividends, lower costs or other economic benefi ts directly and proportionately to its owners, members or participants. Common examples of mutual entities are credit unions, mutual insurance companies and co-operatives. Combinations of mutual entities were excluded from the scope of the original IFRS 3.



At present, a combination of mutual entities is accounted for either in accordance with the acquisition method or the pooling of interests method. As a consequence, the accounting for combinations of mutual entities is not consistent, either within that sector or with other business combinations. Therefore, we proposed removing the scope exemption for combinations of mutual entities.


Respondents that commented on the proposal were mostly mutual entities or their representative organisations. The majority of respondents disagreed that combinations of mutual entities should be included in the scope of the revised IFRS 3 because they believe that mutual entities have particular characteristics that distinguish them from other business entities.

Many respondents stated that combinations of mutual entities are economically different from business combinations of investor-owned entities. They believed that situations exist in which a combination of mutual entities should not be accounted for in accordance with the acquisition method. In their view, in the case of a ‘merger of equals’, the pooling of interests method or the so-called ‘fresh start’ method provides more faithfully representational information.

Our response

We know that mutual entities have some characteristics that set them apart from investor-owned businesses. However, they also have many common characteristics. As do other businesses, mutual entities strive to provide their members with a fi nancial return or other economic benefi ts. A mutual entity often does that by focusing on providing its members with its products and services at lower prices.

We think that the economic motivation for combinations of mutual entities, such as to provide their constituents with a broader range of, or access to, services and cost savings through economies of scale, are not suffi ciently different from those of other entities to justify different accounting for business combinations. Regardless of the intentions of the combining entities, the general result of a combination involving only mutual entities is that one entity obtains control of another entity.

Applying the fresh start method suggests that none of the combining entities is viewed as having survived the combination as an independent reporting entity. Rather, the combination is viewed as the transfer of the net assets of the combining entities to a new entity that assumes control over them. It is possible that there are combinations of mutual entities for which the fresh start method would provide better information than the acquisition method. However, we have yet to conduct a comprehensive review of the fresh start method and such a review is not part of our active agenda.


Some respondents stated that co-operatives do not fi t within the defi nition of a mutual entity. They argued that co-operatives are different from mutual entities and those differences justify a different method of accounting for combinations of co-operatives.

Our response

We know that there are differences between co-operatives and other types of mutual entities. For example, the objective of a co-operative might include providing social and cultural benefi ts to its community in addition to the economic benefi ts provided to its members. However, co-operatives generally provide direct and indirect economic benefi ts such as dividends, lower costs of services or other products to their members. We concluded that differences in the amount of social and cultural benefi ts that an entity provides are not a suffi cient basis to justify excluding co-operatives from the defi nition of a mutual entity.




For entities that are within the scope of the revised IFRS 3 but were outside the scope of the original IFRS 3, application of the acquisition method is likely to cause a fundamental change in the accounting for business combinations. The resulting statement of fi nancial position of the acquirer, immediately after an acquisition, is likely to differ signifi cantly from the statement of fi nancial position that would have resulted from its previous accounting.

Affected entities will be revealing information about the fair values of assets and liabilities that might not have been known to investors and analysts.

In future periods, it is likely that the affected groups will report lower profi ts if they had been applying the pooling of interests method. This happens because the acquisition method requires assets and liabilities to be measured at fair value whereas the pooling of interests method allowed the acquirer to use old carrying amounts. If an asset with a carrying amount lower than its fair value was sold after the combination, the pooling of interests method would allow the group to recognise a gain. By applying the acquisition method, any gains are likely to be smaller because some of that value will have been recognised at the acquisition date.


Preparers


Signifi cantly higher preparation costs

Negative Mutual entities (and those entities entering ‘by contract alone’ arrangements) are likely to have signifi cantly higher preparation costs, because many have been applying the pooling of interests method, which does not require assets and liabilities to be remeasured.

Users



Positive The costs of monitoring different accounting should be reduced.

Signifi cant increase in comparability

Positive There will be a signifi cant increase in comparability in those combinations involving mutual entities or in which the combination is by contract alone. The accounting will be on the same basis.

Increased usefulness

Positive The quality of the information should improve because the accounting for an acquisition provides more useful information about the ability of the group to generate future cash fl ows.

Classifying and designating assets acquired and liabilities

assumed

The accounting for a lease differs according to whether it is classifi ed as a fi nance lease or as an operating lease. The original IFRS 3 did not provide guidance on whether the classifi cation or designation of an asset or a liability could change in a business combination.

When we developed the exposure drafts we were concerned that practice was diverging, as a result of the lack of guidance. We proposed clarifying that the classifi cation of an acquired lease should not change in a business combination. Therefore, if the acquiree had classifi ed a lease contract as an operating lease before the business combination the acquirer would continue to account for the contract as an operating lease.




Respondents generally agreed with the proposed treatment of lease contracts and thought the guidance was helpful. Some asked us to go further and to provide additional guidance on how to classify or designate other assets acquired and liabilities assumed in a business combination, such as fi nancial assets, embedded derivatives, cash fl ow hedges and insurance contracts.

Our response

We agree with those respondents who requested additional guidance and decided that the best way to address this was to develop a general principle for classifying and designating contracts.

The principle we developed is that the acquirer should classify and designate all items acquired in a business combination at the acquisition date in the context of the contractual terms, economic conditions and other pertinent factors at that date. We decided, however, that two exceptions to that principle should be leases and insurance contracts.

We think that the new principle will provide clarity in an area of divergence in practice. This should reduce compliance costs for preparers and benefi t users of fi nancial statements.


We are not able to assess the effect on the fi nancial statements. Some asset or liability amounts might change, but that will depend on how entities have been accounting for these items when applying the original IFRS 3.


Preparers


Entity-specifi c Neutral Preparation costs should be reduced because we have provided guidance for matters on which preparers are likely to have sought professional advice. However, it is possible that the new guidance will result in a change in accounting for some entities that results in more costs than their current practice.

Users


Analysis costs Neutral The costs of analysis are unlikely to be affected.

Comparability Neutral We are providing guidance that should lead to consistency in how these items are measured. However, in some cases carry-over amounts are required that can reduce comparability between entities. Overall, our assessment is that the information will be more comparable, but the improvements are likely to be small.

Usefulness Neutral Our assessment of the effect on the usefulness of the fi nancial statements is similar to our assessment of comparability.



Intangible assets

We made several changes in relation to intangible assets. We removed the reliability threshold for recognising intangibles, clarifi ed that an assembled workforce must not be recognised, and provided additional guidance in relation to reacquired rights.


Because preparers have been accounting for intangible assets in different ways there might be changes in how these assets are reported, but we are not able to assess how individual entities will be affected.


Preparers


Preparation costs

Neutral We are told by preparers and auditors that removing the reliability threshold will not cause additional intangible assets to be recognised. Thus there should be no additional costs of preparation.

Users


Analysis costs Neutral The costs of analysis are unlikely to be affected.

Comparability Positive The information should be more comparable.

Usefulness Neutral The increased comparability and clarifi cation that an assembled workforce is not a separately recognisable asset should improve the quality of the information about intangible assets. However, there is mixed evidence on the usefulness of recognising intangible assets acquired in the acquisition of a business.

Contingent liabilities

The exposure draft proposed some improvements to the accounting for contingent liabilities. The original IFRS 3 requires contingent liabilities to be measured at fair value at the acquisition date, although an acquirer is not required to recognise a contingent liability if its fair value cannot be measured reliably. The exposure draft proposed removing that exception.

The exposure draft also proposed changes to the measurement of contingent liabilities after the acquisition date. The original IFRS 3 requires entities to measure contingent liabilities at the higher of the amount at which they were initially recognised or the amount that would be required to be recognised in accordance with IAS 37. The exposure draft proposed that, after a business combination, an acquirer should measure contingent liabilities at the amount that an entity would pay to settle or transfer the liability at the reporting date. This was consistent with the accounting for contingent liabilities occurring outside of a business combination proposed in the exposure draft of amendments to IAS 37 (which we published simultaneously with the business combinations exposure drafts).




Respondents generally disagreed with the proposed measurement of contingent liabilities after a business combination, expressing concerns about the ability to measure contingent liabilities reliably, ongoing costs of having to remeasure contingent liabilities at each reporting date and volatility in the statement of comprehensive income.

Our response

We understand the concerns respondents raised, most of which we have been debating as part of our deliberations in the IAS 37 project. We think that it is best to resolve the accounting for contingencies in that project. We therefore decided that the revised IFRS 3 should carry forward the original IFRS 3 requirements, with one difference. We now also require that the contingency must meet the defi nition of a liability. As a consequence, some contingencies that would be recognised when applying the original IFRS 3 will not be recognised when applying the revised IFRS 3.


Contingencies now must meet the defi nition of a liability to be recognised in a business combination. As a consequence, some contingencies that would be recognised when applying the original IFRS 3 will not be recognised when applying the revised IFRS 3. This will also lower the amount of goodwill recognised in those business combinations.


Preparers


Preparation costs are likely to increase for most preparers, but could be reduced for some.

Negative Preparers will have to determine whether contingencies assumed in a business combination satisfy the defi nition of a liability.

Those preparers who identify contingencies that are not liabilities will no longer be required to measure those items at fair value, which will probably reduce their preparation costs.

Users


Analysis costs Neutral It is unlikely that the changes will have much effect on analysis costs.

Comparability Positive Entities will no longer be recognising possible liabilities acquired in a business combination as if they are existing liabilities of the entity. Thus, the accounting for these items is the same whether they are part of or outside a business combination.

Usefulness Positive Users will have information about which contingencies are present obligations and which contingencies are possible obligations.



Other improvements to IAS 27

Attribution of losses

The existing version of IAS 27 requires losses that exceed the non-controlling interests’ equity to be deducted from the controlling interest’s equity. Any profi ts the subsidiary reports subsequently are allocated to the controlling interest until the non-controlling interests’ losses previously absorbed by the controlling interests have been recovered.

The amended IAS 27 requires all losses attributable to the non-controlling interests to be allocated to them, even if this results in the non-controlling interests having a defi cit balance. We have made this change because the present accounting is inconsistent with our conclusion that non-controlling interests are part of the equity of the group.


Some respondents agreed with the proposal because they noted that controlling and non-controlling interests share proportionally in the risks and rewards of the investment in the subsidiary and the proposal was consistent with that view. Others disagreed, arguing that, even though controlling and non-controlling interests are presented in equity, they have different economic characteristics and should not be treated the same way. They highlighted that the non-controlling interests are generally not compelled to cover the defi cit and that if the subsidiary requires additional capital in order to continue operations the non-controlling interests would abandon their investments.

Our response

Although it is true that non-controlling interests have no further obligation to contribute assets to the subsidiary, neither does the parent. If the fi nancial position of a subsidiary subsequently improves, all owners of the subsidiary, including the non-controlling interests, will share in that recovery. Non-controlling interests participate proportionally in the risks and rewards of the subsidiary.

We will review the requirements for disclosures in consolidated fi nancial statements as part of our discussion paper on consolidations.


When the losses attributable to non-controlling interests exceed their carrying amount, the new requirement will result in higher equity attributable to the controlling interest and a lower non-controlling interests balance than the previous version of IAS 27.


Preparers


Preparation costs

Neutral Although the new requirements are simpler to administer, any associated benefi ts are likely to be small and we therefore assess the effect on preparation costs as neutral.



Users


Analysis costs Neutral It is unlikely that the changes will have much effect on analysis costs.

Comparability Neutral The new requirements will not affect comparability.

Usefulness Positive Users will be able to assess the portion of a defi cit that relates to non-controlling interests. This should help them to assess the effect on the shareholders of the parent in terms of whether the parent will need to provide additional assistance to a subsidiary that is in defi cit.

Loss of control of a subsidiary

Sometimes a parent loses control of a subsidiary but retains an ownership interest. Depending on the degree of infl uence the former parent retains in the former subsidiary, the remaining investment is accounted for as a jointly controlled entity, an associate or a fi nancial asset in accordance with other applicable IFRSs. Before we amended IAS 27, it required that at the date control is lost the carrying amount of the retained investment is the initial measurement for its subsequent accounting as a fi nancial asset.

This accounting is not consistent with the general principle in IFRSs that when a fi nancial asset is recognised initially it should be measured at fair value. When a parent entity loses control of a subsidiary the parent stops recognising the assets, liabilities and equity instruments and recognises, for the fi rst time, an investment. That is to say, this is the initial recognition of that investment.

Therefore, we proposed that any investment the parent retains in a former subsidiary after control is lost should be measured initially at fair value, regardless of whether the retained investment is classifi ed as an associate, a jointly controlled entity or a fi nancial asset. At the date when control is lost, the difference between the fair value and carrying amount of the retained interest should be recognised in profi t or loss.


Even though some respondents agreed with the proposal, most respondents disagreed that the former parent should account for the retained investment at fair value and recognise a gain or loss in profi t or loss. They believed that the principles for gain or loss recognition in the Framework would not be satisfi ed for the retained investment in the subsidiary because there was no transaction that justifi ed recognising a value change.

Our response

We think that measuring the investment at fair value is consistent with our conclusion that the loss of control is a signifi cant economic event. The parent-subsidiary relationship ceases to exist and an investor-investee relationship begins that differs signifi cantly from the former parent-subsidiary relationship. Therefore, the new investor-investee relationship is recognised and measured initially at fair value at the date when control is lost.



Measuring a retained investment at fair value will impose some additional costs on preparers of fi nancial statements related to the valuation itself. However, those additional costs should be relatively small because in most cases when control is lost the former parent will have just sold shares and therefore has an exchange transaction that will assist it in measuring the fair value of the shares it has retained.

We also think that measuring the retained investment at fair value provides more relevant information to users of fi nancial statements and is consistent with the proposals for step acquisitions. Therefore, we decided to affi rm the accounting proposed in the exposure draft.


As with a gain or loss associated with a previously held investment in a step acquisition, some respondents argued that the gain or loss should be recognised in other comprehensive income.

Our response

Including any such gain or loss in other comprehensive income would be inconsistent with the fact that the nature of the investment has changed fundamentally—from having control over the assets and liabilities of the business to a non-controlling investment. We therefore retained the proposed accounting.


Entities that retain a non-controlling interest in a former subsidiary are likely to recognise a larger gain than they would by applying the current IAS 27. This is because of the requirement to measure that retained investment at fair value. In such cases, the deemed cost of the investment in the former subsidiary will also be higher, by the same amount.

The fair value of the retained interest might be new information, but it is likely that similar information is already being disclosed.


Preparers


Preparation costs

Neutral The parent will need to make one new fair value measurement. However, in many cases that measurement is being made at the same time that the parent has sold some of the shares in the former subsidiary.

Therefore, we think that these costs will be relatively low. The new guidance on how to measure a gain or loss on disposal should reduce audit costs and the costs of seeking professional advice.

On this basis we have assessed the likely effect on preparation costs as marginally negative.



Users


Analysis costs Neutral Most analysts are already adjusting out of earnings any gain or loss related to the loss of control of a subsidiary. Changing the amount of that adjustment does not affect the costs of analysis.

Comparability Positive Comparability should improve because entities will be measuring the gain or loss on a consistent basis. The initial measurement of the shares in the former subsidiary will also be on a consistent basis.

Usefulness Positive We assess the increased comparability and the more relevant basis for establishing the deemed cost of the investment as combining to improve the usefulness of the information.



General assessment

Business combinations are not as pervasive as acquisitions of, say, property, plant and equipment. Some entities never acquire another business. Therefore, the likely effect of the requirements in IFRS 3 and IAS 27 will depend on the level of this type of activity and the details of the transaction. For example, step and partial acquisitions tend to be more complex than acquisitions of all of the equity of a business.

Preparers

The original IFRS 3 established the accounting for the acquisition of a business and specifi ed what information must be disclosed about the acquisition. In general, neither the original or revised IFRS 3 create ongoing accounting or disclosure burdens. Rather, if an asset is recognised as part of a business combination the accounting and disclosure requirements after that initial recognition are governed by other IFRSs. Our assessment is that the revised IFRS 3 and the amended IAS 27 will not cause preparers to change their accounting systems.

Many of the changes we have made to IFRS 3 and IAS 27 are designed to address areas for which practice is divergent, principally because of an absence of guidance in IFRSs. Our assessment is that these changes will reduce preparation costs by providing preparers with clearer principles.

Users

Our assessment is that the changes to the accounting for business combinations will lead to signifi cant benefi ts to users. The accounting requirements in IFRSs and US GAAP will be substantially the same, making it easier to compare the fi nancial statements of entities undertaking acquisitions whether they apply IFRSs or US GAAP. Most of the changes that have led to this outcome have been made to US GAAP. The changes to IFRSs have, in contrast, been relatively small.

Some of the changes to IFRS 3 and IAS 27 have been made to address divergent practice. That is to say, we are addressing diffi culties in comparing business combinations, and subsequent accounting, within IFRSs.

Taken together, our assessment is that the project will lead to signifi cant improvements in the comparability of business combinations accounted for in accordance with IFRSs and between IFRSs and US GAAP.

Typical business combinations

As we noted earlier, how the changes to IFRS 3 will affect an entity will depend on the terms of the acquisition agreement. In this section we provide an overall assessment of the likely effect of the requirements on two types of business combination—100 per cent acquisitions and step acquisitions. In this analysis we have included comments about changes that the FASB has made to US GAAP.

100 per cent acquisition

Approximately 88 per cent of business combinations that occur in jurisdictions applying IFRSs involve the acquisition of all of the equity of the target entity in one transaction. In such cases there is no previously held investment and no non-controlling interests. This type of acquisition is, therefore, the most common business combination. As a fi rst step, we assume that the acquisition does not include a contingent consideration agreement.



The acquirer is likely to recognise an expense for acquisition costs, which we are told are approximately 1½ per cent of the acquisition price. Some of the assets or liabilities assumed might be accounted for differently as a consequence of the revised IFRS 3 providing clearer recognition principles for items such as leases and embedded derivatives.

Preparers Users

Acquisition costs There is no change in preparation costs.

There are minimal additional assessment costs.

There is no effect on the comparability of the information.

Clarifi cation of initial recognition principle

Effect on preparationcosts is entity-specifi c.

Overall, our assessment is that the information will be more comparable, but the improvements are likely to be small.

US GAAP changes

n/a Improved comparability in relation to restructuring charges, bargain purchases and in-process R&D.

Overall effect Overall, our assessment is that preparation costs are likely to be reduced as a consequence of the amended requirements.

Comparability within IFRSs should improve marginally.

The most signifi cant improvement in comparability will be between IFRS and US GAAP compliant fi nancial statements. The changes made to US GAAP will make the accounting for business combinations more comparable.

100 per cent acquisition—contingent consideration agreement

For those acquisitions that include a contingent consideration agreement the preparation costs will increase because the associated liability will need to be measured at fair value—both initially and at each subsequent reporting period.

Users will have more comparable, more timely and more helpful information about the contingent consideration arrangements.

Step and partial acquisitions

Approximately 12 per cent of business combinations that occur in jurisdictions applying IFRSs involve the acquisition of only a portion of the equity. In a step acquisition, the acquirer owns some of the equity in the target before it achieves control. In a partial acquisition, after achieving control the acquirer does not own all of the equity. That is to say, there are non-controlling interests.

Step acquisition

Assuming that there are no non-controlling interests, the fi nancial statement effects are the same as for a 100 per cent acquisition. In addition, however, the goodwill recognised is likely to be different from that reported in accordance with the original IFRS 3 and the acquirer might also report a gain, or loss, associated with measuring previously held interests at fair value.



Preparers Users

Acquisition costs As with a 100 per cent acquisition


As with a 100 per cent acquisition

Previously held interest

Increased preparation costs, because of the requirement to measure the previously held interests at fair value.

More useful information and improved comparability.

Measurement of goodwill

Reduced preparation costs, because of the removal of the requirement to measure each asset and liability when each tranche of shares was acquired.

More consistent measurement of goodwill.

US GAAP changes n/a Improved comparability in relation to all assets, restructuring charges, bargain purchases and in-process R&D.

Overall effect Overall, our assessment is that preparation costs are likely to be reduced as a consequence of the amended requirements. In some cases this reduction will be signifi cant.

Comparability within IFRSs should improve marginally.


Partial acquisition

The fi nancial statement effects are the same as for a 100 per cent acquisition. In addition, the goodwill and non-controlling interests recognised will be different from that reported in accordance with the original IFRS 3, if the acquirer chooses to measure non-controlling interests at fair value.

Preparers Users

Acquisition costs As with a 100 per cent acquisition


As with a 100 per cent acquisition

Measurement of non-controlling interests

Additional preparation costs if the acquirer chooses to measure non-controlling interests at fair value. Entities measuring non-controlling interests as their proportionate interest in the net identifi able assets have higher ongoing costs associated with administering impairment assessments.

More useful information if fair value is used. Comparability is not affected because it is relatively easy to calculate the non-controlling interests as their proportionate interest in the net identifi able assets of the acquiree.



Preparers Users

US GAAP changes n/a Improved comparability in relation to restructuring charges, bargain purchases and in-process R&D.

Overall effect Overall, our assessment is that, with the exception of measuring non-controlling interests, preparation costs are likely to be reduced as a consequence of the amended requirements. The benefi t of any reduced preparation costs will be mitigated if the acquirer measures non-controlling interests at fair value.

Comparability within IFRSs should improve marginally, although the choice given to acquirers for measuring non-controlling interests could reduce comparability.




ResourcesAdditional information about the project is available on the Business Combinations project page of our Website, at www.iasb.org/business-combinations.

The project page gives access to:

the exposure drafts published in June 2005.

the letters we received in response to our request for comments on the exposure drafts.

audio recordings of the public meetings we held to discuss the project and written summaries of the decisions we made at those meetings.

examples demonstrating the different approaches in practice to accounting for acquisitions and disposals of non-controlling interests, including an assessment of why the accounting in the amended IAS 27 is the most appropriate of these methods.

•

•

•

•

free movement of capital, company law and … · 3 1. executive summary the international...

Documents