FRC Study: Accounting for
Acquisitions, January 2010
Presentation to SSBV
Shân Kennedy
1 February 2010
Purpose of study
• To identify areas for improvement in
accounting for M&A in context of:
– IFRS 3, Business Combinations, introduced
2004
• requirement to recognise intangible assets separately
from goodwill; and
• to provide explanation of components of goodwill
– analyst comment to date on (lack of) usefulness
of information generated by IFRS 3
What we did
• Selected 20 UK listed companies that had
made material acquisitions in 2008
– range of different industries
– included 3 AIM companies
• Reviewed their compliance with
– IFRS 3, Business Combinations; and
– IAS 38, Intangible Assets
How big were the amounts involved?
• Sum of recorded intangible assets and
goodwill
– greater than the purchase price for half the
transactions
– equal to the purchase price on average
• Goodwill alone was approx 2/3 of purchase
price on average
• Intangible assets alone were approx 1/3 of
purchase price on average
Front of annual report – chairman,
CEO, CFO comments
•clear and consistently good
•e.g. forward order books, strong
brand names, distribution networks,
cross-selling synergies
Consistency
between front and
back in only 4
cases
What we found
…pantomime cow??
Back of annual report – audited
accounts
•unclear or obfuscated
•benefits from front neither identified as
intangible assets nor described within
components of goodwill
IFRS intangible asset recognition
requirements
• Must recognise intangible assets distinct
from goodwill if
– the intangible is ‘identifiable’
• This means it is either
– ‘separable’; or
– legally secured
– but not necessarily both of these
Separability of intangible assets
• Intangible can be sold or licensed
independently from the underlying business
• Need not be capable of separation on its
own
– e.g. could be together with another intangible
asset, a liability or a tangible asset
– typical examples - financial services industry
Findings of study
• Two companies had recorded no intangible
assets other than goodwill, but…..
• Fronts of reports had identified several
intangible benefits expected from the
acquisitions
– why were these neither recognised as intangible
assets nor disclosed as components of goodwill?
– had companies performed effective exercises to
ensure all identifiable intangible assets had
been recognised?
Disclosure issues
• Each material class of intangible assets to
be disclosed separately
• A class of intangible assets is a grouping of
intangible assets of a similar nature and use
in an entity’s operations
• e.g. trade marks, internet domain names,
non-compete agreements, customer
contracts, contractual and non-contractual
customer relationships
– see IFRS 3 Illustrative Examples
What we found
• Classes were not disclosed separately for
each material acquisition
– 7 companies displayed classes only in
aggregate for all acquisitions that took place in
the year
• confusing for reader to link the clear narrative at
front of report with obfuscation in audited accounts
• difficult to understand what the intangible assets that
had been recognised represented
Customer-related intangible assets:
specific problems
• 15 companies identified some type of customer-related
intangible asset
• In 2 cases, a class was disclosed comprising the aggregation
of brand values and customer relationships
– but are these of a similar nature and use in a business?
– one may well strengthen over time, whilst the other may suffer
attrition
• 3 companies had disclosed aggregated customer assets
– some or all of customer contracts, customer lists and customer
relationships
• Only one company had differentiated customer contracts
from customer relationships
The class called ‘other’
• Disclosed by 7 of the companies
• 3 included disparate benefits within this one
class, in one case, comprised all of
– purchased and acquired patents, licences and
trade marks, software rights and order backlog
– similar nature and use in an entity’s
operations…
Description of goodwill
• Only 14 companies made any disclosure at all
• Of these we classified 5 as uninformative and 9 as
slightly informative
• What we were looking for
– description of intangible benefits that failed the
identifiability requirement to be separable or legally
secured
• e.g. a team of staff with specific knowledge
– explanation of cross-selling synergies and how they arose
– cross-referencing to the front of the annual report
– i.e. a better understanding of the transaction and
how it had been accounted for
Impact of new IFRS 3, revised 2008
• Must be applied for reporting periods
commencing 1 July 09 onwards
• Key changes affecting intangible asset
recognition
– all intangible assets arising from an acquisition
are capable of reliable measurement
– enhanced guidance regarding separability of
intangible assets
– aggregation of different intangible assets
for valuation purposes
IAS 38: intangible asset aggregation
• Para 37
– The acquirer may recognise a group of
complementary intangible assets as a single
asset provided the individual assets have
similar useful lives
– e.g. the term brand may be used for a group of
complementary assets such as a trademark and
its related trade name, formulas, recipes and
technological expertise
Looking further forwards
• Fair Value Measurement Exposure Draft
• Reliability hierarchy of valuation inputs
• Sensitivity analysis for valuations assessed
as Level 3
• Many valuation definitions that will apply
to all valuation exercises
– market participants, fair value, principal market
and most advantageous market
• IFRS expected Q3 2010
FRC Study: Accounting for
Acquisitions, January 2010
Presentation to SSBV
Shân Kennedy
1 February 2010