BC97 In developing ED 3 and the IAS 38 Exposure Draft, the Board had concluded that, except for an assembled workforce, sufficient information could reasonably be expected to exist to measure reliably the fair value of an asset that has an underlying contractual or legal basis or is capable of being separated from the entity. Respondents generally disagreed with this conclusion, arguing that:
(a) it might not always be possible to measure reliably the fair value of an asset that has an underlying contractual or legal basis or is capable of being separated from the entity.
(b) a similar presumption does not exist in IFRSs for identifiable tangible assets acquired in a business combination. Indeed, the Board decided when developing the IFRS to carry forward from IAS 22 the general principle that an acquirer should recognise separately from goodwill the acquiree's identifiable tangible assets, but only provided they can be measured reliably.
BC98 Additionally, as part of its consultative process, the Board conducted field visits and round-table discussions during the comment period for the Exposure Draft. Field visit and round-table participants were asked a series of questions aimed at improving the Board's understanding of whether there might exist non-monetary assets without physical substance that are separable or arise from legal or other contractual rights, but for which there may not be sufficient information to measure fair value reliably.
BC99 The field visit and round-table participants provided numerous examples of intangible assets they had acquired in recent business combinations whose fair values might not be reliably measurable. For example, one participant acquired water acquisition rights as part of a business combination. The rights are extremely valuable to many manufacturers operating in the same jurisdiction as the participant—the manufacturers cannot acquire water and, in many cases, cannot operate their plants without them. Local authorities grant the rights at little or no cost, but in limited numbers, for fixed periods (normally 10 years), and renewal is certain at little or no cost. The rights cannot be sold other than as part of the sale of a business as a whole, therefore there exists no secondary market in the rights. If a manufacturer hands the rights back to the local authority, it is prohibited from reapplying. The participant argued that it could not value these rights separately from its businesses (and therefore from the goodwill), because the businesses would cease to exist without the rights.
BC100 After considering respondents' comments and the experiences of field visit and round-table participants, the Board concluded that, in some instances, there might not be sufficient information to measure reliably the fair value of an intangible asset separately from goodwill, notwithstanding that the asset is 'identifiable’. The Board observed that the intangible assets whose fair values respondents and field visit and round-table participants could not measure reliably arose either:
*The field visits were conducted from early December 2002 to early April 2003, and involved IASB members and staff in meetings with 41 companies in Australia, France, Germany, Japan, South Africa, Switzerland and the United Kingdom. IASB members and staff also took part in a series of round-table discussions with auditors, preparers, accounting standard-setters and regulators in Canada and the United States on implementation issues encountered by North American companies during first-time application of US Statements of Financial Accounting Standards 141 Business Combinations and 142 Goodwill and Other Intangible Assets, and the equivalent Canadian Handbook Sections, which were issued in June 2001.
(a) from legal or other contractual rights and are not separable (ie could be transferred only as part of the sale of a business as a whole); or
(b) from legal or other contractual rights and are separable (ie capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability), but there is no history or evidence of exchange transactions for the same or similar assets, and otherwise estimating fair value would be dependent on variables whose effect is not measurable.
BC101 Nevertheless, the Board remained of the view that the usefulness of financial statements would be enhanced if intangible assets acquired in a business combination were distinguished from goodwill, particularly given the Board's decision to regard goodwill as an indefinite-lived asset that is not amortised. The Board also remained concerned that failing the reliability of measurement recognition criterion might be inappropriately used by entities as a basis for not recognising intangible assets separately from goodwill. For example, IAS 22 and the previous version of IAS 38 required an acquirer to recognise an intangible asset of the acquiree separately from goodwill at the acquisition date if it was probable that any associated future economic benefits would flow to the acquirer and the asset's fair value could be measured reliably. The Board observed when developing ED 3 that although intangible assets constitute an increasing proportion of the assets of many entities, those acquired in business combinations were often included in the amount recognised as goodwill, despite the requirements in IAS 22 and the previous version of IAS 38 that they should be recognised separately from goodwill.
BC102 Therefore, although the Board decided not to proceed with the proposal that, with the exception of an assembled workforce, sufficient information should always exist to measure reliably the fair value of an intangible asset acquired in a business combination, the Board also decided:
(a) to clarify in IAS 38 that the fair value of an intangible asset acquired in a business combination can normally be measured with sufficient reliability for it to be recognised separately from goodwill. When, for the estimates used to measure an intangible asset's fair value, there is a range of possible outcomes with different probabilities, that uncertainty enters into the measurement of the asset's fair value, rather than demonstrates an inability to measure fair value reliably.
(b) to include in IAS 38 a rebuttable presumption that the fair value of a finite-lived intangible asset acquired in a business combination can be measured reliably.
(c) to clarify in IAS 38 that the only circumstances in which it might not be possible to measure reliably the fair value of an intangible asset acquired in a business combination are when the intangible asset arises from legal or other contractual rights and it either (i) is not separable or (ii) is separable but there is no history or evidence of exchange transactions for the same or similar assets and otherwise estimating fair value would be dependent on variables whose effect is not measurable.
(d) to include in the IFRS a requirement for entities to disclose a description of each asset that meets the definition of an intangible asset and was acquired in a business combination during the period but was not recognised separately from goodwill, and an explanation of why its fair value could not be measured reliably.
BC103 Some respondents and field visit participants suggested that it might also not be possible to measure reliably the fair value of an intangible asset when it is separable, but only together with a related contract, asset or liability (ie it is not individually separable), there is no history of exchange transactions for the same or similar assets on a stand-alone basis, and, because the related items produce jointly the same cash flows, the fair value of each could be estimated only by arbitrarily allocating those cash flows between the two items. The Board disagreed that such circumstances provide a basis for subsuming the value of the intangible asset within the carrying amount of goodwill. Although some intangible assets are so closely related to other identifiable assets or liabilities that they are usually sold as a 'package', it would still be possible to measure reliably the fair value of that 'package’. Therefore, the Board decided to include the following clarifications in IAS 38:
(a) when an intangible asset acquired in a business combination is separable but only together with a related tangible or intangible asset, the acquirer recognises the group of assets as a single asset separately from goodwill if the individual fair values of the assets in the group are not reliably measurable.
(b) similarly, an acquirer recognises as a single asset a group of complementary intangible assets constituting a brand if the individual fair values of the complementary assets are not reliably measurable. If the individual fair values of the complementary assets are reliably measurable, the acquirer may recognise them as a single asset separately from goodwill, provided the individual assets have similar useful lives.
BC104 As noted in paragraph BC90, the Board also considered whether the criteria for recognising intangible assets separately from goodwill should also be applied to in-process research and development projects acquired in a business combination, and concluded that they should. In reaching this conclusion, the Board observed that the criteria in IAS 22 and the previous version of IAS 38 for recognising an intangible asset acquired in a business combination separately from goodwill applied to all intangible assets, including in-process research and development projects. Therefore, the effect of those Standards was that any intangible item acquired in a business combination was recognised as an asset separately from goodwill when it was identifiable and could be measured reliably, and it was probable that any associated future economic benefits would flow to the acquirer. If those criteria were not satisfied, the expenditure on that item, which was included in the cost of the combination, was attributed to goodwill.
BC105 The Board could see no conceptual justification for changing the approach in IAS 22 and the previous version of IAS 38 of using the same criteria for all intangible assets acquired in a business combination when assessing whether those assets should be recognised separately from goodwill. The Board concluded that adopting different criteria would impair the usefulness of the information provided to users about the assets acquired in a combination, because both comparability and reliability would be diminished.
BC106 Some respondents to ED 3 and the IAS 38 Exposure Draft expressed concern that applying the same criteria to all intangible assets acquired in a business combination to assess whether they should be recognised separately from goodwill results in treating some in-process research and development projects acquired in business combinations differently from similar projects started internally. The Board acknowledged this point. However, it concluded that this does not provide a basis for subsuming those acquired intangible assets within goodwill. Rather, it highlights a need to reconsider the view taken in IAS 38 that an intangible asset can never exist in respect of an in-process research project and can exist in respect of an in-process development project only once all of the criteria for deferral in IAS 38 have been satisfied. The Board concluded that such a reconsideration is outside the scope of its Business Combinations project.
Contingent liabilities
BC107 ED 3 proposed, and the IFRS requires, an acquirer to recognise separately the acquiree's contingent liabilities (as defined in IAS 37 Provisions, Contingent Liabilities and Contingent Assets) at the acquisition date as part of allocating the cost of a business combination, provided their fair values can be measured reliably. In reaching its decision to include this requirement in the IFRS, the Board observed that provisions for terminating or reducing the activities of an acquiree that were previously recognised in accordance with paragraph 31 of IAS 22 as part of allocating the cost of a combination (but which the IFRS prohibits from being so recognised; see paragraphs BC76-BC87) are not contingent liabilities of the acquiree. A contingent liability is defined in IAS 37 as (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity, or (b) a present obligation that arises from past events but is not recognised either because it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation or because the amount of the obligation cannot be measured with sufficient reliability. In the case of provisions for terminating or reducing the activities of an acquiree that were previously recognised in accordance with paragraph 31 of IAS 22, there is no present obligation, nor is there a possible obligation arising from a past event whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
BC108 However, some respondents to ED 3 suggested that the acquiree and acquirer could agree for the acquiree to take the steps necessary to satisfy the recognition criteria for restructuring provisions in IAS 37, but to make the execution of the plan conditional on the acquiree being acquired in a business combination. This could circumvent the prohibition in the IFRS on recognising restructuring provisions as part of allocating the cost of a combination. Unlike the circumstances contemplated by the Board in paragraph BC85, if the business combination does not take place the acquiree is under no obligation to proceed with the plan. Respondents suggested that, in such circumstances, it might be possible to argue that the restructuring plan is, before the business combination, either one of the following:
(a) a possible obligation of the acquiree that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events. Therefore, the acquirer could recognise it as a contingent liability of the acquiree when allocating the cost of the combination.
(b) a present obligation of the acquiree that is regarded as a contingent liability until it becomes probable that a business combination will occur. This obligation could then be recognised as a liability by the acquiree, in accordance with IAS 37, when a business combination becomes probable and the liability can be measured reliably. Respondents suggested that this would be consistent with paragraph 41 of ED 3 (with slightly revised wording, that paragraph is now paragraph 42 of the IFRS), which stated that 'A payment that an entity is contractually required to make to, for example, its employees or suppliers in the event it is acquired in a business combination is a present obligation of that entity that is regarded as a contingent liability until it becomes probable that a business combination will take place. The contractual obligation is recognised as a liability by that entity under IAS 37 when a business combination becomes probable and the liability can be measured reliably. Therefore, when the business combination is effected, that liability of the acquiree is recognised by the acquirer as part of allocating the cost of the combination.'
BC109 The Board disagreed that a restructuring plan whose execution is conditional on a business combination is either (a) a possible obligation of the acquiree that, before the business combination, meets part (a) of the definition of a contingent liability, or (b) a present obligation of the acquiree that is regarded as a contingent liability until it becomes probable that a business combination will take place. This is because:
(a) a possible obligation meets the definition of a contingent liability only when it satisfies all of the following criteria:
(i) it arises from past events;
(ii) its existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events; and
(iii) the uncertain future event(s) is (are) not wholly within the control of the entity.
The Board concluded that a restructuring plan whose execution is conditional on a business combination, although meeting the criteria in (i) and (ii) above, fails to meet the criterion in (iii). This is because the uncertain future event (ie being acquired in a business combination) is generally within the acquiree's control.
(b) the acquiree has not, before the business combination, established a present obligation. In accordance with paragraph 72 of IAS 37, a constructive obligation to restructure arises only when an entity has:
(i) a detailed formal plan for the restructuring; and
(ii) raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.
The Board concluded that if execution of the plan is conditional on the acquiree being acquired in a business combination, then the criterion in (ii) has not been satisfied. Even if the main features of the plan were announced to those that would be affected by it, the 'valid expectation’ would be conditional on the entity being acquired in a business combination—a possibility that is not provided for in the wording of paragraph 72 of IAS 37.
BC110 Therefore, to avoid any confusion or possibility of circumventing the Board's intention in relation to the treatment of restructuring provisions, the Board decided to clarify in paragraph 43 of the IFRS that an acquiree's restructuring plan whose execution is conditional upon it being acquired in a business combination is not, immediately before the business combination, a present obligation of the acquiree, nor is it a contingent liability of the acquiree. Therefore, an acquirer shall not recognise such restructuring plans as part of allocating the cost of the combination.
BC111 In developing ED 3 and the IFRS, the Board observed that although a contingent liability of the acquiree is not recognised by the acquiree before the business combination, that contingent liability has a fair value, the amount of which reflects market expectations about any uncertainty surrounding the possibility that an outflow of resources embodying economic benefits will be required to settle the possible or present obligation. As a result, the existence of contingent liabilities of the acquiree has the effect of depressing the price that an acquirer is prepared to pay for the acquiree, ie the acquirer has, in effect, been paid to assume an obligation in the form of a reduced purchase price for the acquiree.
BC112 The Board observed that this highlights an inconsistency between the recognition criteria applying to liabilities and contingent liabilities in IAS 37 and the Framework (both of which permit liability recognition only when it is probable that an outflow of resources embodying economic benefits will be required to settle a present obligation) and the fair value measurement of the cost of a business combination. Indeed, the probability recognition criterion applying to liabilities in IAS 37 and the Framework is fundamentally inconsistent with any fair value or expected value basis of measurement because expectations about the probability that an outflow of resources embodying economic benefits will be required to settle a possible or present obligation will be reflected in the measurement of that possible or present obligation. However, the Board agreed that the role of probability in the Framework should be considered more generally as part of a forthcoming Concepts project.
BC113 The Board also observed that the principles in IAS 37 had been developed largely for provisions that are generated internally, not obligations that the entity has been paid to assume. This is not dissimilar from situations in which assets are recognised as a result of the business combination, even though they would not be recognised had they been generated internally. For example, some internally generated intangible assets are not permitted to be recognised by an entity, but would be recognised by an acquirer as part of allocating the cost of acquiring that entity.
BC114 In developing ED 3 the Board proposed that a contingent liability recognised as part of allocating the cost of a business combination should be excluded from the scope of IAS 37 and measured after initial recognition at fair value with changes in fair value recognised in profit or loss until settled or the uncertain future event described in the definition of a contingent liability is resolved. While considering respondents' comments on this issue, the Board noted that measuring such contingent liabilities after initial recognition at fair value would be inconsistent with the conclusions it reached on the accounting for financial guarantees and commitments to provide loans at below-market interest rates when revising IAS 39 Financial Instruments: Recognition and Measurement.
BC115 The Board decided to amend the proposal in ED 3 for consistency with IAS 39. Therefore, the IFRS requires contingent liabilities recognised as part of allocating the cost of a combination to be measured after their initial recognition at the higher of:
(a) the amount that would be recognised in accordance with IAS 37, and
(b) the amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.
The Board observed that not specifying the subsequent accounting might result in some or all of these contingent liabilities inappropriately being derecognised immediately after the combination.
BC116 To avoid any confusion over the interaction between IAS 39 and the above requirement, the Board also decided to clarify in the IFRS that:
(a) the above requirement does not apply to contracts accounted for in accordance with IAS 39.
(b) loan commitments excluded from the scope of IAS 39 that are not commitments to provide loans at below-market interest rates are accounted for as contingent liabilities of the acquiree if, at the acquisition date, it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation or if the amount of the obligation cannot be measured with sufficient reliability. Such a loan commitment is recognised separately as part of allocating the cost of a combination only if its fair value can be measured reliably.
BC117 The Board is considering as part of the second phase of its Business Combinations project whether items meeting the definition in IAS 37 of contingent assets should also be recognised separately as part of allocating the cost of a business combination. However, the Board decided that it was necessary to address contingent liabilities of the acquiree in the first phase of its project, given that it had agreed to reconsider the requirements in IAS 22 for the treatment of negative goodwill as part of that first phase. The Board observed that negative goodwill as determined in accordance with IAS 22 could have arisen as a result of, amongst other things, failure to recognise contingent liabilities of the acquiree that the acquirer had been paid to take on in the form of a reduced purchase price.
Contractual obligations of the acquiree for which payment is triggered by a business combination
BC118 The IFRS clarifies that a payment an acquiree is contractually required to make, for example, to its employees or suppliers in the event it is acquired in a business combination, would be recognised by the acquirer as part of allocating the cost of the combination. The Board agreed that before the business combination, such a contractual arrangement gives rise to a present obligation of the acquiree. That present obligation meets the IAS 37 definition of a contingent liability until it becomes probable that a business combination will take place. Once it becomes probable that a business combination will take place, the obligation should, in accordance with IAS 37, be recognised as a liability by the acquiree provided it can be measured reliably. Therefore, when the business combination is effected, the liability is recognised by the acquirer as part of allocating the cost of the combination.
BC119 The Board concluded that the treatment in IAS 22 of such obligations was ambiguous, and that the IFRS should therefore clarify their treatment.
BC120 However, as outlined in paragraphs BC108-BC110, the Board clarified that an acquiree's restructuring plan whose execution is conditional on the acquiree being acquired in a business combination is not, immediately before the business combination, a present obligation of the acquiree.
Measuring the identifiable assets acquired and liabilities and contingent liabilities incurred or assumed (paragraphs 36 and 40)
BC121 IAS 22 included a benchmark and an allowed alternative treatment for the initial measurement of the identifiable net assets acquired in a business combination, and therefore for the initial measurement of any minority interests. The Board agreed that permitting similar transactions to be accounted for in dissimilar ways impairs the usefulness of the information provided to users of financial reports, because both comparability and reliability are diminished. The Board concluded that the quality of Standards would be improved by omitting the option that existed in IAS 22 from the IFRS arising from the first phase of its Business Combinations project. ED 3 proposed, and the IFRS requires, the acquiree's identifiable assets, liabilities and contingent liabilities recognised as part of allocating the cost of the business combination to be measured initially by the acquirer at their fair values at the acquisition date. Therefore, any minority interest in the acquiree will be stated at the minority's proportion of the net fair value of those items. Almost all of the respondents to ED 3 supported the proposal, which was consistent with the allowed alternative treatment in IAS 22.
BC122 Applying IAS 22's benchmark treatment, the acquirer would have initially measured each of the acquiree's identifiable assets and liabilities at the aggregate of:
(a) its fair value at the date of the exchange transaction, but only to the extent of the ownership interest obtained by the acquirer in the exchange transaction; and
(b) the minority's proportion of its pre-combination carrying amount.
BC123 In assessing IAS 22's benchmark treatment, the Board noted that the requirement in IAS 27 Consolidated and Separate Financial Statements to prepare consolidated financial statements is driven by the existence of a group. The objective of consolidated financial statements is to provide users with relevant and reliable financial information about the resources under the control of the parent entity so as to reflect that the related entities operate as a single economic entity. Therefore, under IAS 27 the consolidated financial statements for the group are intended to reflect the performance of that group and the resources under the control of the parent entity, irrespective of the extent of the ownership interest held. As a result, IAS 27 requires consolidation of all of the identifiable assets and liabilities of the controlled entity; a proportionate approach to the preparation of consolidated financial statements is not permitted. Accordingly, with the exception of goodwill arising on the acquisition of a subsidiary, 100 per cent of a subsidiary's assets and liabilities are included in the consolidated financial statements from the date on which the parent obtains control of that subsidiary, irrespective of the ownership interest held in the subsidiary.
BC124 The Board concluded that the mixed measurement reported in accordance with IAS 22's benchmark treatment was inconsistent with the consolidation approach in IAS 27 and with the objective of providing users with relevant and reliable financial information about the resources under the control of the parent entity.
BC125 The Board noted that the allowed alternative treatment provided users with information about the fair values at the acquisition date of the acquiree's identifiable assets and liabilities, together with any minority interest in those fair values. The Board concluded that this treatment was consistent with the consolidation approach adopted in IAS 27 and the objective of consolidated financial statements because the information it provided enabled users to better assess the cash-generating abilities of the identifiable net assets acquired in the business combination. The Board also noted that the allowed alternative treatment provided users of the group's consolidated financial statements with more useful information for assessing the accountability of management for the resources entrusted to it.
BC126 The Board considered the view that, notwithstanding the use in IAS 27 of control to define the boundaries of a group, the focus of consolidated financial statements remains the owners of the parent. On that basis, and because the cost of a business combination relates only to the percentage of the identifiable net assets acquired by the parent, those identifiable net assets should be measured at their fair values only to the extent of the parent's interest obtained in the exchange transaction. In other words, the minority's proportionate interest in the identifiable net assets acquired by the parent is not part of the exchange transaction and therefore should be stated on the basis of pre-combination carrying amounts. Those supporting this approach argue that it is consistent with the requirement in IAS 22 to recognise only the amount of goodwill acquired by the parent based on the parent's ownership interest, rather than the amount of goodwill controlled by the parent as a result of the combination.
BC127 However, the Board concluded that the use in IAS 27 of control to define the boundaries of a group remains fundamental to identifying the objective of consolidated financial statements, even if the intended focus of those statements were the owners of the parent. In a consolidation model whose intended focus is the owners of the parent but which uses control to define the boundaries of the group, the objective of the consolidated financial statements for that group would be to provide information to the owners of the parent about the resources under their control, irrespective of the extent of the ownership interest held by the parent in those resources. The Board concluded that information about the fair values at the acquisition date of the acquiree's identifiable assets, liabilities and contingent liabilities provides the owners of the parent with more useful information about the resources under their control than the mixed measurement reported under the benchmark treatment.
BC128 The Board nonetheless observed that the requirement in IAS 22 to recognise only the amount of goodwill acquired by the parent based on the parent's ownership interest, rather than the amount of goodwill controlled by the parent as a result of the business combination, is problematic. The Board saw this as a flaw in the way that IAS 22 interacted with IAS 27 rather than an indication that consolidated financial statements prepared in accordance with IAS 27 are intended to reflect only the resources attributable to owners of the parent on the basis of the ownership interests held by the parent. The Board concluded that if this were indeed the objective of consolidated financial statements, then a proportionate approach to consolidation for all of the assets acquired and liabilities assumed in a business combination would be the only approach to satisfy that objective. The Board is reconsidering the requirement to recognise only the amount of goodwill acquired by the parent on the basis of the parent's ownership interest as part of the second phase of its Business Combinations project.
Goodwill (paragraphs 51-55)
Initial recognition of goodwill as an asset
BC129 ED 3 proposed, and the IFRS requires, goodwill acquired in a business combination to be recognised by the acquirer as an asset and initially measured as the excess of the cost of the combination over the acquirer's interest in the net fair value of the acquiree's identifiable assets, liabilities and contingent liabilities. Almost all of the respondents to ED 3 supported these proposals. Except for the effect on the measurement of acquired goodwill of recognising the acquiree's contingent liabilities (see paragraphs BC107-BC117), these requirements are consistent with the requirements previously in IAS 22. However, the Board decided that the IFRS should not confuse measurement techniques with concepts and therefore, unlike IAS 22, the IFRS defines goodwill in terms of its nature rather than its measurement. In particular, the IFRS defines goodwill as future economic benefits arising from assets that are not capable of being individually identified and separately recognised.
BC130 In developing ED 3 and the IFRS, the Board observed that when goodwill is measured as a residual, it could comprise the following components:
(a) the fair value of the 'going concern’ element of the acquiree. The going concern element represents the ability of the acquiree to earn a higher rate of return on an assembled collection of net assets than would be expected from those net assets operating separately. That value stems from the synergies of the net assets of the acquiree, as well as from other benefits such as factors related to market imperfections, including the ability to earn monopoly profits and barriers to market entry.
(b) the fair value of the expected synergies and other benefits from combining the acquiree's net assets with those of the acquirer. Those synergies and other benefits are unique to each business combination, and different combinations produce different synergies and, hence, different values.
(c) overpayments by the acquirer.
(d) errors in measuring and recognising the fair value of either the cost of the business combination or the acquiree's identifiable assets, liabilities or contingent liabilities, or a requirement in an accounting standard to measure those identifiable items at an amount that is not fair value.
