Proposed amendments to IFRS 3, or: who’s misaligning our concepts?

The IASB has published Reference to the Conceptual Framework, an exposure draft of proposed amendments to IFRS 3, with comments to be received by September 27, 2019.

This one’s not easy to explain with any kind of relative plain language concision, but I’ll give it a shot. IFRS 3 says that to qualify to be recognized as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must meet the definition of assets and liabilities in the conceptual framework: however, it currently refers to an old version of the framework rather than to the 2018 update. The IASB had left the outdated reference in place out of concern that to update it without making any other changes to IFRS 3 might carry unintended consequences – such as changing the population of assets or liabilities recogniszd in a business combination. The Board decided to first analyze the possible unintended consequences and ways of avoiding them.

The main such problems would seem to flow from standards that don’t themselves align with the new conceptual framework definitions. IAS 37, addressing provisions, requires that a provision is recognized when, among other things, “it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.” In contrast, the revised conceptual framework defines a liability as “a present obligation of the entity to transfer an economic resource as a result of past events” and comments: “the obligation must have the potential to require the entity to transfer an economic resource to another party (or parties). For that potential to exist, it does not need to be certain, or even likely, that the entity will be required to transfer an economic resource—the transfer may, for example, be required only if a specified uncertain future event occurs.” It’s clear then that the “probable” threshold required by IAS 37 is higher than what the conceptual framework requires for liabilities in general. The consequence of this could be as follows:

  • IFRS 3 specifies that after the acquisition date an acquirer accounts for most types of assets and liabilities recognized in a business combination in accordance with other IFRS Standards applicable to those items. As a result, some assets or liabilities recognized in a business combination (i.e. if recognized with reference only to the conceptual framework says) might not qualify for recognition subsequently. In such cases, the acquirer would have to derecognize the asset or liability and recognise a resulting loss or gain immediately after the acquisition date. That so-called ‘day 2’ loss or gain would not depict an economic loss or gain, so would not be a faithful representation of any aspect of the acquirer’s financial performance.

The solution to this then is to provide an exception to the general recognition principle of IFRS 3, so that a provision wouldn’t be recognized in the acquisition equation in the first place unless it met the threshold in IAS 37, thus eliminating any possible day 2 inconsistency. As always, the Board considered other options. It’s currently gathering evidence to help it decide whether to start a project to amend IAS 37, and so could have waited to see whether such a project takes care of the problem by aligning its requirements with those of the framework. However: “it is not certain that the Board will amend IAS 37 in this way and, even if it does so, the process of developing amendments, including exposing proposals for comment, could take some years. In the meantime, the Board would continue to have more than one version of its Conceptual Framework in use, which could confuse those applying IFRS Standards.”

Alternatively, it could have expanded IFRS 3 to add some requirements for subsequent accounting, but that would also have taken longer, among other problems. Or it might have changed IFRS 3 to direct that “for assets or liabilities that would be within the scope of another IFRS Standard if acquired or incurred separately, any asset or liability recognised must meet the definition of an asset or a liability applied in that Standard.” But this too would take longer, given the necessary research to identify possible other unintended consequences.

The exposure draft takes a similar approach toward levies recognized under IFRIC 21, reflecting that IFRIC 21 is an interpretation of IAS 37 and so the issues arising are the same. It also addresses contingent assets. The conceptual framework isn’t entirely definitive on whether or when these would be recognized. It discusses cases where “an entity and another party might dispute whether the entity has a right to receive an economic resource from that other party” and says: “Until that existence uncertainty is resolved—for example, by a court ruling—it is uncertain whether the entity has a right and, consequently, whether an asset exists.” It adds that: “In some cases, that uncertainty, possibly combined with a low probability of inflows or outflows of economic benefits and an exceptionally wide range of possible outcomes, may mean that the recognition of an asset or liability, necessarily measured at a single amount, would not provide relevant information.” But the use of “in some cases” and “may mean” stops short of giving an outright: Don’t do it! In the exposure draft, the IASB proposes eliminating any question by saying flatly that the acquirer shall not recognize a contingent asset at the acquisition date.

And that’s the best I could do with that topic…

The opinions expressed are solely those of the author

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