In March, the International Accounting Standards Board (IASB) published an Exposure Draft (ED) proposing amendments to International Financial Reporting Standard (IFRS) 3 Business Combinations and International Accounting Standard (IAS) 36 Impairment of Assets. The objective of the ED is to address users’ needs for better information about the performance of business combinations and to reduce the cost and complexity of the impairment test. This article highlights our major comments on the EDs. The full response is available on our website.
Overall, we agree with the proposed disclosures to IFRS 3 that they should only be applied to a subset of material business combinations, subject to an exemption. However, we have significant concerns in the following areas:
Scope of strategic business combinations
We see the merits of applying a threshold approach as it is easier to use, audit and enforce. Nevertheless, we are concerned that the proposed thresholds would not effectively capture the intended population of strategic business combinations as described in BC54 of the ED for the following reasons:
- The proposed 10 percent threshold appears too low compared to the local listing rules to provide additional information for significant acquisitions.
- The proposed quantitative thresholds only focus on the size of business combinations in terms of revenue, operating profit or loss and total assets, without considering the strategic value of the transactions. Furthermore, when calculating the thresholds, the acquirer and acquiree’s financial information may be distorted e.g. due to significant non-recurring items, making it unrepresentative of the usual state of their financial performance and position.
- The proposed qualitative threshold lacks clarity on whether it is targeting major and strategically important acquisitions geographically.
If the IASB’s intention were to capture only sizable business combinations, we recommend the IASB reset the proposed threshold to a higher one to align more closely with capital market regulations, provide guidance and clarifications to address the above identified issues, and rename the term “strategic” to another term, such as “major” or “substantial”, to reflect the specific criteria that characterise the relevant business combinations.
However, if the IASB’s intention were to identify both strategically important and sizable business combinations, we suggest the IASB consider using a principle-based approach with BC54 as the principle and the proposed thresholds as indicators rather than determinative factors. Entities could rebut the presumption by providing reasonable justifications and additional disclosures.
Disclosure of key objectives, targets and expected synergies
We have identified the following practical questions about disclosing key objectives, targets and expected synergies, and recommend the IASB provide guidance.
- An entity’s objectives for an acquisition are often broad and subjective, making it difficult to identify the key objectives. In particular, our respondents questioned whether potential risk factors that could adversely impact the achievement of the key objectives should be disclosed.
- For key objectives that are non-financial related, such as branding, technological and innovation-related benefits, the ED is not clear as to whether, and if so, how entities should set the measurable targets and quantify the expected synergies.
- The ED lacks clarity on the meaning of “synergies”. Specifically, our respondents questioned whether the proposed disclosures intend to capture the revenue of the combining operations or incremental revenue.
Exemption from disclosures
The application of the disclosure exemption requires significant judgement in identifying circumstances that “can be expected to prejudice seriously the achievement of any of the acquirer’s acquisition-date key objectives for the business combination”. However, the proposed application guidance lacks sufficient direction on the specific circumstances for such an exemption. It is also unclear whether the exemption would only apply in “extremely rare cases”, similar to the exemption in IAS 37 Provisions, Contingent Liabilities and Contingent Assets. This leaves room for interpretation and subjectivity in restricting the exemption only to the appropriate circumstances.
Therefore, we recommend the IASB provide application guidance and examples of legitimate circumstances that qualify for the disclosure exemption. This recommendation, together with those on the scope of strategic business combinations and disclosures of key objectives, targets and expected synergies explained above, could enhance the overall robustness of the proposals and mitigate any potential debate between preparers and auditors.
Expectation gap on the level of assurance provided
Our practitioners expressed significant concerns that users and regulators might assume auditors had verified the existence and achievability of key objectives, targets and expected synergies disclosed in audited financial statements. This creates an expectation gap between the assurance provided by auditors and the assurance perceived by users, exposing auditors to litigation risk.
To address this, we recommend the IASB specify in the body of IFRS 3 that the disclosures represent management’s best estimate at the time of acquisition, with no guarantee that the actual results will align with the disclosures. Entities should disclose this management assertion in the financial statements. We believe this approach would be consistent with paragraph 122 of IFRS 18 Presentation and Disclosure in Financial Statements, which requires a company to disclose a statement to set appropriate expectations around the nature and reliability of the information provided and help mitigate the expectation gap.
This article was contributed by Kennis Lee, Associate Director and Sam Chan, Manager of the Institute’s Standard Setting Department.
