CR Common Practices Accounting for Business Combinations

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1 Introduction Under International Accounting Standards, accounting for business combinations is governed by IFRS 3 Business combinations, as recently revised as part of the convergence project between IFRS and US GAAP. The objective of this standard is to improve the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about business combinations and their effects. An underlying principle of the standard is that the acquiring company shall measure the identifiable assets acquired and the liabilities assumed at their acquisition date fair values (para 18) with such values being disclosed for each major class of assets acquired and liabilities assumed (para B64(i)). The acquirer has a choice when measuring any non-controlling interest and may arrive at a value based on either fair value or the proportionate share of the acquiree s identifiable net assets (para19). Any premium existing when comparing the fair value of the consideration paid to the aggregate net fair value of the assets acquired and the liabilities assumed constitutes goodwill with the company being required to give a qualitative description of the factors that make it up (B64(e)). Focusing on a sample drawn from 24 large listed European companies that report under IFRS, supplemented by Company Reporting data and comment, this report analyses company disclosures in relation to assets acquired and liabilities assumed with particular attention paid to intangible assets. Secondly, it draws on the disclosures provided regarding the reasons why company goodwill arises. A further area of interest is the treatment of non-controlling interests. Key observations include the following. The majority of companies present acquisition fair value information in a tabular format which, more often than not, continues to include an analysis of pre-acquisition book values and adjustments. Following business combinations, intangible assets are often recognised for the first time at a significant value, with large value increases in relation to some intangibles that already existed pre-acquisition also being recognised. In general, companies could give a clearer explanation on why and how goodwill arises. Most companies make reference to synergies without giving any guidance to what these are. Companies under examination Our initial sample consists of 24 listed European company accounts, which feature in the Standard & Poor s Europe 350 dataset with period ends from 30 June 2010 and which had reported by early February The sample contains a spread of industry classes. The companies of which the accounts have been analysed are as follows: Company Period end Auditors Country Industry class Associated British Foods 18 September 2010 KPMG UK Food products BHP Billiton 30 June 2010 KPMG UK General mining British Sky Broadcasting 30 June 2010 Deloitte UK Broadcasting & entertainment Compass 30 September 2010 Deloitte UK Restaurants & bars Daily Mail & General Trust 03 October 2010 Deloitte UK Publishing Diageo 30 June 2010 KPMG UK Distillers & vintners Hays 30 June 2010 Deloitte UK Business training & employment agencies Imperial Tobacco 30 September 2010 PricewaterhouseCoopers UK Tobacco Infineon Technologies 30 September 2010 KPMG Germany Semiconductors Kone 31 December 2010 PricewaterhouseCoopers Finland Industrial machinery Lonmin 30 September 2010 KPMG UK Platinum & precious metals 1

2 Mediobanca 30 June 2010 Ernst & Young Italy Banks Novartis 31 December 2010 PricewaterhouseCoopers Switzerland Pharmaceuticals Novozymes 31 December 2010 PricewaterhouseCoopers Denmark Biotechnology Pernod Ricard 30 June 2010 Mazars & Deloitte France Distillers & vintners Porsche 31 July 2010 Ernst & Young Germany Automobiles Roche 31 December 2010 KPMG Switzerland Pharmaceuticals Sage 30 September 2010 PricewaterhouseCoopers UK Software SGS 31 December 2010 Deloitte Switzerland Business support services Siemens 30 September 2010 Ernst & Young Germany Electronic equipment Smiths 31 July 2010 PricewaterhouseCoopers UK Diversified industrials Sodexo 31 August 2010 PricewaterhouseCoopers & KPMG France Restaurants & bars ThyssenKrupp 30 September 2010 KPMG Germany Iron & steel Wolseley 31 July 2010 PricewaterhouseCoopers UK Industrial suppliers Analysis Within our sample, 12 companies give some form of disclosure in respect of current year business acquisitions with a further five making an explicit statement that either no acquisitions or no material acquisitions took place during the year. In the absence of any reference to current year acquisitions it is assumed that IFRS 3 is largely irrelevant to the remaining seven companies in the current year although some make reference to prior year acquisitions. Company Current Year Acquisitions Explicit Statement of Non Existence No Disclosure of Existence Associated British Foods BHP Billiton Compass Diageo Mediobanca Novozymes Porsche Sage Siemens Sodexo ThyssenKrupp Imperial Tobacco Novartis British Sky Broadcasting Daily Mail and General Trust Hays Infineon Technologies Kone Lonmin Pernod Ricard Roche SGS Smiths Wolseley 2

3 Immaterial Acquisitions Of the companies giving some form of disclosure, ThyssenKrupp and Wolseley state that acquisitions made have an immaterial impact on the financial statements. Despite this, however, Wolseley discloses the name of a company acquired and the consideration paid along with a segmental analysis that shows the impact of acquisitions on revenue and trading profit (see Illustrative Extract 1). ThyssenKrupp, in contrast, discloses an aggregate fair value table which includes pre-acquisition asset and liability carrying amounts, adjustments and acquisition date fair values. Neither the names of the companies acquired nor any further business combination disclosures are presented within the financial statements although information is disclosed within the management review section of the annual report (see Illustrative Extract 2). No Fair Value Table Under IFRS 3, companies are required to disclose information that enables users of its financial statements to evaluate the nature and financial effect of business combinations (para 59). Specific information that should be presented includes the fair value of assets and liabilities at acquisition date, the consideration paid and any resulting goodwill. All companies with evidence of current year business combinations, with the exception of Siemens and Wolseley, present such information in a tabular format. Wolseley does not disclose the fair value of assets or liabilities or the resulting goodwill specifically, noting the immaterial nature of its business combinations. Siemens opts to give limited asset fair value information which refers only to intangible assets in a narrative format. The exclusion of other asset and liability fair value amounts and the adoption of such a format lead to a lack of transparency in comparison to other companies. Other business combination information, such as the name of the company acquired and the income statement impact, is also disclosed in a narrative format (see Illustrative Extract 3). Acquisitions in Aggregate Of the 10 companies in our sample adopting a tabular format, six present a main table within their business acquisitions note which includes only aggregate information for a number of business combinations. However, the tables presented by these companies differ. Kone and Diageo present tables which give only asset and liability fair value information whereas Compass additionally discloses pre-acquisition book values. Daily Mail and General Trust, ThyssenKrupp and Novartis go even further by presenting separately adjustments made to pre-acquisition book values (see Illustrative Extracts 4 and 5). The companies which present information in addition to the acquisition date fair values go beyond that required by revised IFRS 3 with the disclosure of the book values and adjustments being a requirement of IFRS 3 before revision. In a move which arguably leads to increased transparency, eight out of the 10 companies in our sample to present a fair value table continue to give this information. In addition to the presentation of aggregate fair value tables Daily Mail and General Trust and Novartis also present additional quantitative information for individual business combinations outwith their main fair value tables elsewhere. Daily Mail and General Trust presents summarised consideration, intangible fixed asset and goodwill information for what it describes as notable acquisitions. Novartis presents a summary table showing the financial impact of consolidating a single material business combination 3

4 achieved in stages. This table gives only a total value for all net assets acquired with individual fair value adjustments being identified (see Illustrative Extracts 6 and 7). Individually Material Acquisitions The remaining 4 companies present, in their main fair value tables, information for individual business combinations. In the case of Sage, individual information is given as only one business combination has taken place during the year. In line with IFRS 3 (para B64), SGS, Smiths and Roche give separate information for single material acquisitions with aggregate information presented for others. SGS and Smiths both use a combined table format to show material acquisitions and others in aggregate, whereas Roche presents two completely separate tables (see Illustrative Extracts 8 and 9). Of the three companies to present information for individually material and other acquisitions, Roche is the only one to disclose income statement impacts separately for its individually material acquisition. The remaining two give only aggregate information. Roche presents the income statement impacts of individually material acquisitions split into its two divisions. In addition to revenue and profit information it also includes amortisation of intangible assets in its analysis. It also presents a divisional analysis of business combination capital expenditure by segment (see Illustrative Extract 10). The majority of other companies disclose aggregate income statement impacts, although Diageo and Kone do not on the grounds of materiality. Intangible Assets When looking at the acquisition fair value tables presented, the prominence of intangible assets cannot be overstated. In many cases, intangible assets account for the majority of fair value adjustments with assets that were not previously recognised in the financial statements of the acquired company now recognised. On acquisition, the companies in our sample recognise a range of different intangible assets. Common Types Of Intangible Assets Number of Companies Brands/Trademarks 5 Customer Intangibles 4 Technology 5 Contract Related 2 Product Intangibles 2 Acquired R&D 2 Other 4 The transparency with which these intangibles are disclosed differs from company to company. The majority of companies identify the nature of the intangibles acquired in a business combinations note, however, in the case of Daily Mail and General Trust, SGS and Sage, such notes only refer to intangible assets with separate disclosure given only in a discrete intangible assets note. This is possibly down to the materiality of individual intangible assets. There is also variety between companies when identifying the exact nature of the intangibles recognised. Compass, for 4

5 example, is somewhat vague as to the nature of its intangibles referring to them only as contract and other intangibles (see Illustrative Extract 11). Kone also recognises contract related intangibles but is more specific as to their nature explicitly identifying that they are in relation to maintenance contracts. Another company that could improve the clarity of disclosures in relation to the nature of specific intangibles recognised is Roche which refers to product intangibles in use and product intangibles not available for use without giving any further guidance. In the financial statements of the acquired company, these intangibles were not recognised but following acquisition they have a significant fair value of over CHF530 million. Fellow pharmaceuticals company Novartis refers to marketed products but includes these in aggregate with marketing know-how. Again, there is a significant jump in intangibles following acquisition with the amount recognised increasing from US$186 million to US$16.5 billion. Both companies also disclose technology as a type of intangible asset which is a common type of intangible disclosed by other companies. Novartis identifies a range of intangible assets giving both pre and post acquisition carrying amounts for each (see Illustrative Extract 12). Goodwill In addition to recognising separately identifiable intangible assets, each company in our sample with evidence of material acquisitions also recognises goodwill which represents the future economic benefits arising from other assets acquired in a business communication that cannot be individually identified and separately recognised. Whether identifiable intangible assets or goodwill is of greater value differs from company to company. Company Intangible Assets Value % Goodwill Value % Other SGS Sage Diageo Daily Mail & General Trust Kone Smiths Roche Novartis Compass Siemens Company explanations of what goodwill represents also differ. Siemens is the only company to offer no explanation of what its goodwill represents. There is also room for improvement in relation to the descriptions given by other companies. All other companies as part of their descriptions make reference to synergies without specifically identifying what these synergies are. In the case of Diageo, that is the only explanation given. Another common area identified by SGS, Sage and Kone is the workforce or business knowledge. A further common explanation for goodwill relates to the markets in which companies operate. Kone refers to increased market share whereas Daily Mail and General Trust mentions the introduction of products to new markets and Compass cites cross selling opportunities. In 5

6 addition, Compass rather opaquely refers to its goodwill as simply representing the premium paid. Roche also refers to a premium but is more specific when identifying its nature as it discloses that it relates to a premium paid to gain control. In general, all companies in our sample could give fuller information in relation to what goodwill represents possibly by identifying more closely the exact synergies achieved. Despite not doing this, a company which gives a relatively full explanation for its goodwill is Sage which refers to synergies, assembled workforce and economic benefits from integration of services. Non-Controlling Interests Under IFRS 3, companies have a choice when measuring non-controlling interests. Such interests can either be measured at fair value or at the non-controlling interests proportionate share of the acquiree s identifiable net assets (para 19). Of the companies with current year acquisitions, only Daily Mail and General Trust, Novartis and ThyssenKrupp show evidence of non-controlling interests in relation to the companies acquired. Within its accounting policies note, ThyssenKrupp notes that the interests of minority shareholders are stated at the minority s proportion of the fair values of the identifiable assets, liabilities and contingent liabilities recognised. In contrast, Daily Mail and General Trust and Novartis both state that non-controlling interests in relation to current year acquisitions are measured using the minority shareholders proportionate share of identifiable net assets. Both Daily Mail and General Trust and Novartis give additional information. The former states that, although it acquired only a 50% equity share in a company, it accounts for its interest as a subsidiary as it has the ability to control the composition of the company s board of directors and the latter that it will acquire its non-controlling interest in 2012 at a value of US$168 per share which reflects the share price used to determine the fair value of the business on acquisition. Despite showing no evidence of non-controlling interests in relation to current year acquisitions, both Associated British Foods and Roche disclose how such interests would be valued. Associated British Foods states that non-controlling interests are measured at the proportionate share of the net identifiable assets acquired whereas Roche states that such interests are instead recorded as the proportion of the fair value of the acquired net assets attributable to the non-controlling interest. Our analysis shows that although all companies making reference to the measurement of non-controlling interests do not use identical terminology. Each of those in our sample which disclose a method opt for the proportionate share of the acquiree s identifiable net assets. Final or provisional fair values Novartis is the only company in our sample to state explicitly that its acquisition fair values are final. Diageo and Sage do not identify whether the fair values disclosed are final or not. However, the other companies in our sample specifically state that fair values are provisional, thus leaving them open to change within a measurement period which, under IFRS, shall not exceed one year from the acquisition date. A number of companies in our sample make adjustments in respect of previous year acquisition provisional fair values. A particularly transparent presentation for such changes is adopted by Compass which adds a separate column to its current year fair value table showing such adjustments. Despite there being no evidence of current year business acquisitions, Mediobanca presents a table showing the finalisation of fair values in respect of an acquisition carried out at the end of its 2008 financial year (see Illustrative Extracts 13 and 14). 6

7 Stand out companies Roche is worthy of praise as it discloses clearly information in relation to a separately material business acquisition including the income statement impact. A second company worthy of note is Novartis as it gives detailed information in relation to acquired intangible assets. In contrast, Siemens could improve its business combination disclosures by giving fuller information in relation to assets acquired and liabilities assumed including an explanation of the factors that led to goodwill. There would be added clarity if a tabular format was adopted. There is also room for improvement in relation to the disclosures given by Kone and Diageo as neither discloses pre acquisition book values and fair value adjustments whereas peer companies continue to do so despite such disclosures no longer being required under revised IFRS 3. Summary - Conclusion Our principal conclusions are that: The majority of companies present acquisition date fair value information in a tabular format which, more often than not, continues to include pre acquisition book values and adjustments. Following business combinations, intangible assets are often recognised for the first time at a significant value with large value increases in relation to some intangibles recognised pre-acquisition also being a factor. In general, companies could give a clearer explanation of how goodwill recognised on an acquisition arises. Most companies make reference to synergies without giving any guidance to what these are. The proportionate share of the acquiree s identifiable net assets is the method of choice when measuring noncontrolling interests. 7

8 Illustrative Extracts Wolseley: Change in revenue/trading profit (Extract 1) 8

9 ThyssenKrupp: Aggregate fair value table (Extract 2) 9

10 Siemens: Acquisition narrative disclosure (Extract 3) 10

11 Kone: Acquisition fair values (Extract 4) 11

12 Daily Mail and General Trust: Fair value table (Extract 5) Daily Mail and General Trust: Notable acquisitions (Extract 6) 12

13 Novartis: Business Combination summary financial impact (Extract 7) CR Common Practices Smiths: Material and other acquisitions combined table format (Extract 8) 13