Complexities in accounting for acquisitions of groups of assets

Here’s another issue recently discussed by CPA Canada’s IFRS Discussion Group:

• IFRS 3 Business Combinations provides specific guidance on how to allocate the cost of acquisition when an entity acquires a group of assets that does not constitute a business. Paragraph 2(b) of IFRS 3 indicates that the cost of acquisition should be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of acquisition.

• However, a potential conflict arises when the group of assets acquired include financial instruments. Paragraph 43 of IAS 39 Financial Instruments: Recognition and Measurement generally requires an entity to measure individual financial instruments at fair value. Paragraphs AG64 and AG76 of IAS 39 also provide guidance on whether the difference between the transaction price and the fair value of the individual financial instruments at the date of acquisition should be recognized as an immediate gain or loss.

Against that backdrop, the group discussed the following fact pattern:

• An entity acquires a group of assets, including both financial instruments and non-financial items, which do not meet the definition of a business under IFRS 3. While the transaction price represents the fair value of the group of assets, there is a difference between the sum of the fair values of the net identifiable assets acquired and consideration paid. The entity has assessed that there are no other identifiable assets or liabilities causing the difference.

The group discussed various alternatives for allocating the cost of the purchase to the identifiable assets and liabilities acquired. You might first follow IFRS 3 to allocate the acquisition price to each of the identifiable assets and liabilities in the bundle based on their relative fair values; then apply IAS 39 to determine the fair value of each individual financial instrument (which might differ if, say, there’s a “level 1” price that isn’t the same as the transaction price the two parties negotiated); and if there’s a difference, then recognize a day one gain or loss (when the criteria in IAS 39 for doing that are met). You might allocate the acquisition price based on a relative fair value basis without looking initially to IAS 39 and then apply that standard from day two onwards – an approach presumably more likely to generate significant remeasurement gains and losses at that point. Alternatively, you might apply IAS 39 first because it’s the more specific standard pertaining to initially recognizing and measuring a financial asset or liability. There would be a few potential  ways of doing that, but the most obvious might be to measure all financial instruments at fair value first, and then allocate the residual between everything else based on relative fair value.

The group generally supported an approach along the lines of that last option, while noting other approaches might be appropriate depending on the specific facts and circumstances. In a way, it might seem funny this issue arises as often as it does – if one is just selling a bundle of separate assets, with none of the complexities that arise in valuing a business (because there’s no integrated “whole” with a value exceeding the sum of the separate parts), then you might expect the overall transaction price to reflect a rational, fully-informed fair value for each individual item. On this, one group member made the following relevant comment: “the motives of the relevant parties in a transaction can have a significant effect on the negotiated transaction price, which may not be indicative of the fair value of the underlying net assets of a transaction. For example, if a seller is motivated to sell a portfolio of financial instruments to meet certain regulatory requirements, the seller may negotiate a price that is lower than the fair value to expedite the transaction.” But in truth, from what I’ve seen, the complexities arise just as often from irrational negotiations and determinations, for example when an entity issues more shares in an asset purchase than can logically be justified. These problems are particularly common, of course, for smaller entities with thinly-traded stocks – another frequent example occurs when entities issue units consisting of common stock and warrants at a price lower than (sometimes much lower than) their theoretical separate fair values.

Anyway, the group recommended that the issue be discussed with the AcSB to determine whether it should be raised to the IASB or IFRS Interpretations Committee. It ended up a few months later on the IFRIC agenda, where IFRIC acknowledged the possibility of different approaches. It decided not to add the issue to its agenda though, noting it hadn’t “obtained evidence that the outcomes of applying the (different approaches) would be expected to have a material effect on the amounts that entities report.” So that seems to be the end of that.

As a final note, the IFRS Discussion Group also discussed the treatment of transaction costs, taking the view that it’s reasonable first to allocate the acquisition price excluding those costs, and then to allocate the costs based on the relevant guidance of other standards.

The opinions expressed are solely those of the author