In a competitive field, I would award the silver medal for the worst accounting standard to IFRS 3, Business Combinations, with IAS 7, Statement of Cash Flows, comfortably taking gold. I was therefore very pleased when the International Accounting Standards Board (IASB) started looking at targeted improvements to IFRS 3 (see the AB article).
In a masterly piece of understatement, the exposure draft states that the post-implementation review of IFRS 3 revealed that users ‘need better information’. As with cashflow, it would be difficult to make the current standard worse.
For many companies, acquisitions are the largest consumer of discretionary investment. Assessing whether the money has been spent wisely is a key test of management skill and stewardship. Successful acquisitions can transform the fortunes of a company, especially when they are a part of a regular diet.
The converse is also true. There are many examples of failed acquisitions resulting in deteriorating performance, financial distress, management turmoil and even corporate failure. This is an issue that really matters to investors.
Getting inside acquisition accounting is often an exercise in frustration
I spent a lot of my career as an analyst trying to get inside acquisition accounting. It was often an exercise in frustration, even with additional voluntary disclosure. Before looking at the IFRS 3 exposure draft, it is worth stepping back and considering what an investor wants to know. The answers are really quite simple.
Tell all
The first thing I want to know is the all-in purchase price. By ‘all-in’ I mean allowing for acquired debt and cash, the value of shares or other assets transferred to the vendor, pensions and other quasi-debt liabilities, and other items such as advance payments and unusual working capital arrangements. In other words, the enterprise value of the deal after all relevant adjustments. This is often impossible to derive, especially with large and complex deals.
Then I want to know what has been bought. I don’t just want the rationale and description; I want the annualised current sales and operating profit so I can do a simple return-on-investment calculation.
The words ‘annualised’ and ‘current’ are crucial here. Dated or part-year information is just not good enough. Annualised current figures will give an immediate feel for value and leads on to the next question: what improvements are anticipated?
Over time I became more and more sceptical about synergies in general and revenue synergies in particular. In my experience, very few cost synergies materialise in full, and negative revenue synergies are more common than positive ones. Buying an overlapping business will often lead to lost customers, and buying one with no overlap means making conquest sales. This observation isn’t always true, but exceptions are rare in my experience.
It is easy to imagine auditors being sued because the synergies they signed off on fail to materialise
Simple requests
I think my shopping list is reasonable: what did you pay, what did you get, and what do you plan to do with it? The exposure draft improves disclosure on points one and two, but still falls short.
Large, complex deals would still be problematic to unravel and the operating profit would be as per IFRS18 – ie, after the amortisation of synthetic quasi-goodwill intangibles. Both these weaknesses could easily be addressed at this stage, ideally with a single comprehensive table listing all the key acquisition numbers.
The suggested disclosure on synergies is comprehensive and welcome but unrealistic in my view. Synergies are always aspirational and forecasting them is more guesswork than science. The ED reads as if the authors think that synergies are just another number that can be audited. In reality, auditors will have to rely heavily on management judgment.
If I were an auditor, I would be worried about this. It is easy to imagine auditors being sued because the synergies they signed off on fail to materialise. I think synergy discussion belongs in management commentary.
The IASB can do better.
