The challenges of presenting an asset or disposal group as held for sale for longer than twelve months
Here’s another of the issues arising from extracts of enforcement decisions issued in the past by the European Securities and Markets Authority (ESMA) (for more background see here); this is from their 11th edition:
- “The issuer reported a subsidiary as held for sale and its results as those from discontinued operations in its annual financial statements for both 2008 and 2009.
- The issuer’s 2008 financial statements had previously been reviewed by the enforcer. In that review, the enforcer had accepted that the shareholders had, at a general meeting of the company, authorized management to sell 51% of its shares in the subsidiary. The enforcer had accepted that the subsidiary be accounted for as an asset held for sale and presented as a discontinued operation in the issuer’s 2008 financial statements.
- This accounting treatment, however, had been continued in the issuer’s 2009 financial statements and for a period considerably longer than the 12 months specified for such treatment in IFRS 5. Furthermore, the issuer applied the same accounting treatment in respect of all three quarterly reports in 2010.
- In its 2008 financial statements the issuer showed a loss from discontinued operations of m.u. 2.7 million against a total loss of m.u. 2.3 million . For 2009, the corresponding amounts were a loss of m.u. 0.9 million compared with a total profit of m.u. 1.2 million.”
In this case, the enforcer (as ESMA likes to term it) concluded that presenting the subsidiary as a held for sale asset and as a discontinued operation didn’t comply with IFRS 5, because the issuer didn’t meet the criteria specified in the standard for extending the period to complete the sale beyond twelve months. Among other things, the enforcer reviewed “evidence in the form of various draft agreements and correspondence with investment bankers” related to the disposal, and found this material didn’t support the contention that the subsidiary was available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of such disposal groups. Also: “it became clear that the issuer had made certain organizational changes during 2010 which resulted in additional activities being transferred to the subsidiary, (confirming) that the subsidiary was not available for sale in its present condition as at the point of classification (and) that the shareholders’ authorization to sell the subsidiary in 2008 was only granted for one year and that this was not prolonged by the subsequent shareholders’ meeting in 2009.”
Variations on this situation aren’t too uncommon in practice. One can likely see the rather fiendish appeal of taking a business unit that (let’s say) is underperforming and might or might not have to be sold or wound up, and shoving it onto a kind of second tier of financial reporting where its poor performance doesn’t attract the same degree of scrutiny from investors, because it’s perceived as being out the door anyway, and therefore irrelevant to assessing future prospects. I recall a situation years ago under old Canadian GAAP where an entity contrived to show a particular subsidiary as a discontinued operation for years on end. Obviously, the IASB is wise to that possibility, and has carefully considered the circumstances in which an asset or disposal group might acceptably be presented as held for sale for more than a year. Two of these scenarios are quite specific, addressing situations where regulatory or other conditions inevitably extend the period until closing a sales transaction. The other is a bit broader, referring to situations where, during the one year period, “circumstances arise that were previously considered unlikely,” but where management has taken actions necessary to respond to those changes, and continues to actively market the asset or group for sale. IFRS 5.IG7 specifies for example that this includes a scenario where, during the initial one year period, “the market conditions that existed at the date the asset was classified initially as held for sale deteriorate” and the price has been consequently reduced, but without yet attracting a satisfactory offer.
Such situations are very likely to attract the attention of regulators though – they’re specifically designed to be visible to readers (albeit visible in a way that invites the reader to ignore them) – and so the treatment should be carefully considered and documented. This doesn’t seem to have been the case in ESMA’s example. It’s appealing to think (although of course this is no more than my imagination) that having got past a regulatory review in 2008, the issuer felt safe for years to come, and so didn’t bother to plug some obvious holes in the supporting evidence (such as the expiry of the one year shareholders’ authorization). Transferring additional activities to the subsidiary, in its third year of being “held for sale,” seems like the financial reporting equivalent of a movie scene where the bank robbers look in the rear view mirror, conclude they’re not being pursued anymore, and so ease up on the gas. But in this particular movie, the cops caught up anyway!
The opinions expressed are solely those of the author