IFRS: A game of two halves !! Contradiction inherent in the standards IFRS3 and IAS37 I have just won over £1 billion on the ‘Galactic Lotto’ and foolishly decided to sink some of the cash into football. So I buy Liverpool Football Club from Fenway. Not unreasonably, Fenway want to get some return if Liverpool get into the Premiership top four next season and qualify for Europe. They argue that any outstanding performance next season must be partly down to Fenway management. I accept, but I also want equivalent protection from an awful first season. So Fenway and I agree the following terms: • £250m now in cash. • £220m in one year if Liverpool finishes in the top half of the table next season (80%). • £121m in two years if Liverpool finishes in the top four next season (15%). The probabilities are given above and the net assets are valued at £230m at acquisition. I buy all the shares and so there is no non-controlling interest. The cost of capital is 10%. That is plenty enough to calculate the goodwill, which requires both consideration and net assets to be valued at fair value. I am not a massive fan of double entry but I think it will help me make my point. So here goes: Dr Consideration 425 Cr Bank 250 Cr Current liability (220x80%/1.1) 160 Cr Non-current liability (121x15%/1.12) 15 You probably know that the two liabilities represent contingent consideration liabilities and as said previously that is measured at fair value. So the goodwill is measured as follows: £m Fair value of consideration 425 Fair value of net assets (230) Goodwill 195 So far, so good. But what I have not told you is that litigious claimants are trying to get their grubby hands on my winnings. There are two in particular. The first has an 80% chance of getting £220m in one year’s time and the second has a 15% chance of getting £121m in two years’ time. The timing and the probabilities are identical to those above for the contingent consideration. But these two are simple contingent liabilities and are not valued at fair value. Instead, these liabilities use an on/off switch style of recognition where probable outflows (>50%) are recognised in full and others are not recognised at all (being either disclosed or ignored altogether). So I ignore the second liability and recognise the first in full as follows: Dr Cost 200 Cr Current liabilities (220/1.1) 200 So when I draw up my balance sheet a few days after the acquisition I find that I have inconsistency between my liabilities. Of course, identical liabilities should be recognised the same but they are not. How did this ridiculous situation arise? What we have hit upon is the clash between IFRS3 on business combinations and IAS37 on provisions. The newer standard, IFRS3, was developed with getting a fair value for goodwill in mind and as a result used fair value for contingent consideration. The International Accounting Standards Board (IASB) thought nothing of this as it was both logical and in tune with a wider aim of getting all contingencies at fair value. But when the IASB actually came to roadshow their ideas on contingencies at fair value then a riot broke out in the ivory towers of financial reporting. The IASB thought maybe that it was the way that they had presented their ideas that was the problem. So they withdrew the project and later reissued a simplified proposal. But again it was roundly thrown back in their faces. So that was it. Game over. We now find ourselves in the bizarre situation where two identical liabilities are recognised differently depending on whether they are tied up in an acquisition or not.
Posted on: Tue, 15 Oct 2013 06:49:34 +0000
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