IFRS3 AND FAS141

Financial Management, Apr 2008 by Whitwell, Stuart

Stuart Whitwell analyses changes to the FASB's and IASB's standards on business combinations and considers how close they are to convergence.

In December 2007 and January 2008 respectively, the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued revised standards on business combinations. These revised standards take significant steps toward the standard-setters' declared goal of convergence.

This achievement should not be underestimated, as a set of common global standards was always going to be the primary objective, whatever the shortcomings of those standards. It seems that common sense has prevailed, with the best of both standards being adopted without either party stubbornly defending its existing standard.

The two boards are to be applauded for their efforts and encouraged to go the last mile to complete convergence urgently. Only then, I suspect, will there be an appetite to address the weaknesses that remain.

Application of the revised international standard

The good news for firms reporting under International Financial Reporting Standard 3: "Business combinations" (IFRS3) is that the revised standard makes few changes and some of these are of limited application. Many business combinations will not involve contingent consideration or step acquisitions. The only change that will affect all business combinations is that the costs of the acquisition must now be expensed instead of being included in the purchase price.

For US-listed companies, the changes to Statement of Financial Accounting Standards No 141 : "Business combinations" (FAS141) are more substantial, but they all serve to eliminate treatment differences between US Gaap and IFRS, and so reduce workloads.

I would urge companies to pay more attention to applying the existing standard well, particularly to ensure that their intangible assets are realistically valued and disclosed. But I believe that there is a need to monitor and enforce compliance, other than the external audit, as the Securities and Exchange Commission (SEC) does in the US.

The components of goodwill must be disclosed in published accounts - a requirement widely ignored in the early days of IFRS3. I believe that it's good practice to prepare a full-value analysis of the components of goodwill to support the amount reported in the purchase price allocation. Ultimately, this should form part of the accounting standard. This would require companies to be more open and realistic about the amount reported as goodwill.

The changes and remaining differences

FAS141 covers all business combinations initiated after June 30, 2001. IFRS3 had an effective date of March 31, 2004, although many jurisdictions adopted IFRS later than this.

In December 2007 the FASB issued a revised FAS141 (FAS141R), which is mandatory from the annual reporting period starting on or after December 15, 2008. Entities are not permitted to apply the new standard early.

The revised IFRS3 (IFRS3R) was issued in January 2008 and is effective for accounting periods starting on or after July 1, 2009. Unlike FAS141R, it may be applied earlier.

The table below summarises the main changes to FAS141 that bring it into line with IFRS3. The table on the bottom of the next page summarises the changes made to both standards. No changes affect IFRS3 alone.

Remaining differences

Saint Augustine said: "Give me chastity and continence, but not yet," and the boards seem to have taken a similar approach. While striving for convergence, they have decided to issue new standards that still differ, although they will consider most of the differences in future convergence projects. This is disappointing because, at best, it delays completion of the convergence process. Could they not have gone the extra mile to finish the job?

Having said that, the first big difference listed by the FASB is in the definition of the acquirer and identifying the acquirer. The reason cited for a continuing difference is the absence in IFRS of any guidance equivalent to that legend of obfuscation, FASB Interpretation No 46 (Revised) "Consolidation of variable interest entities" (FIN46R).

While the issues that FIN46R attempts to address are only too real - off-balance sheet vehicles beloved of Enron and others - it is the worst example I have ever seen of detailed accounting rules trying to corral the excesses of creative accounting. You might as well try to nail blancmange to a wall. If ever there were an area where principles-based standards were required, this is it. Agreement between FASB and IASB on this will need a lot of work.

The other significant remaining differences are summarised in the table on the right.

Where do we go from here?

Clearly, there is a commitment to achieve further convergence, but this falls short of what should be the short-term objective. The next step must be a common standard for business combinations - the boards should say so unequivocally and set a target date for achieving this.

We need to stand back and take a good look at how business combinations are reported to stakeholders and how well stakeholders' needs are served. We must get past convergence in order to address two bigger issues: the shortcomings common to both standards and the effectiveness of the standards' application.