Is it possible to imagine a principles-based accounting system where all the principles set out for different items perfectly align with each other…?
…maybe a system where everything is measured at fair value, and all the changes go through a single measure of profit or loss? Of course, such a system would bring more measurement challenges than anyone wants, among a hundred other reasons why it’ll never happen. That being so, we’ll probably never run out of fact patterns where analogizing with different standards might indicate different treatments. Such is the wild world of the IFRIC or, in Canada, of the IFRS Discussion Group.
The Group recently considered a situation where an “Entity A” acquires one or more assets that don’t constitute a business – the assets are property, plant and equipment to be accounted for in accordance with IAS 16. Entity A pays cash consideration to the seller at the time of the purchase and agrees to pay additional amounts in one year’s time based on a combination of factors, including meeting defined production milestones and profitability measures. Although “IFRS 3 Business Combinations is clear that contingent consideration payable in a business combination should be recognized at fair value as part of the purchase price….IFRSs do not contain explicit guidance on the accounting for contingent consideration if the assets acquired do not constitute a business as defined in IFRS 3.”
One view – the contingent consideration should be measured at fair value and recorded as part of the cost of the purchase: “IAS 16 requires items to be initially recognized at cost. Cost is the cash equivalent price at the time of purchase, which can be argued to include the contractual arrangement to pay contingent consideration. As discussed in IFRS 3, contingent consideration in a business combination will often meet the definition of a financial instrument. Contingent consideration that is contractually agreed upon in an asset purchase is no different…” Some of the group noted this view could be supported by guidance in IAS 39 regarding financial liabilities that contain variability in payments, and that it’s difficult to ignore the contingent consideration in an asset acquisition if the facts and circumstances closely resemble a business combination.
An alternate view – it should be measured and recorded at a later date, such as when the conditions attaching to the contingency are met. “For example, in the fact pattern at hand, if Entity A chooses not to meet the production milestones, the contingent consideration will not be paid. Therefore, Entity A controls, and can avoid, the obligation to pay consideration. This view is consistent with the principles of IAS 37 Provisions, Contingent Liabilities and Contingent Assets. In accordance with IAS 37, only those obligations arising from past events that exist independently of the entity’s future actions are recognized as provisions. The amount recognized as a provision is the best estimate of the expenditure required to settle the obligation.”
Or maybe it could be one or the other, perhaps depending in part on the degree of economic compulsion attaching to the milestones – that is, whether it would be practical to avoid them (if there are significant penalties for instance). Many members of the group thought neither view could be rejected altogether.
From there, it’s a natural segue to the situation where entity A sells one or more assets that don’t constitute a business, to Entity B. The assets are again property, plant and equipment to be accounted for in accordance with IAS 16. Entity B pays Entity A cash consideration at the time of the purchase and agrees to pay additional amounts in one year’s time based on a combination of factors, as before. The reference points here are a little different, but support a similar diversity of opinion. For one view, the amounts should be measured at fair value and recorded as part of the sale proceeds: “IAS 18 Revenue requires revenue to be recorded at the fair value of the consideration received or receivable. The contractual agreement with the buyer to pay additional amounts is part of the consideration receivable. As discussed in IFRS 3, contingent consideration in a business combination will often meet the definition of a financial instrument. Contingent consideration that is contractually agreed upon in an asset sale is no different.”
Alternatively, the amount might be regarded as a contingent asset that shouldn’t be recorded until realized, or perhaps the appropriate treatment again depends on all the facts and circumstances. Group members expressed diverse views on this matter too. In both cases, the group recommended monitoring relevant IASB activities, and noted that entities entering into transactions for which no explicit IFRS guidance exists should disclose in their notes the method of accounting they applied.
If it were me, I would have voted in both cases to recognize and measure the amounts as part of the core transaction, dealing with the measurement uncertainty through profit or loss in future periods. If you have to analogize to other parts of IFRS, I’d be more inclined to analogize to the standards that sturdily advocate transparency and fair value, rather than to the more shadowy, ad hoc bits of it. But even if you agree with that way of summing up the issue, it seems there’s nothing in IFRS that compels you to jump one way or the other….
The opinions expressed are solely those of the author