While fair value is the standard valuation basis for the measurement of assets and liabilities in the preparation of balance sheet following an acquisition, the new IFRS 3 (IFRS 3 revised or IFRS 3R) requests an even wider use of the notion of fair value. Moreover, IFRS 3R requires the amount of goodwill to be fixed at the date at which the control is obtained.
Consequently, a change in fair value subsequent to the acquisition date will not result in an adjustment to goodwill as with the current version of IFRS 3, even in a buyout context (subject to a 12-month period allowed for finalising the business combination accounting).
Another impact of IFRS 3R will be the rise in number and complexity of valuations to be performed when acquiring new businesses. Indeed, the fair value measurement has been expanded to include contingent considerations (e.g. earn-out clauses), whether probable at the acquisition date or not. The fair value measurement has also been expanded to include re-assessment and potential reclassification of some financial instruments.
A third consequence is a potential greater volatility of the results as adjustments (subsequent to the acquisition balance sheet date) to the identified assets and liabilities values (and goodwill) will directly impact the income statement.
Another change is that transaction costs will not be part of the purchase price anymore. Transaction costs will have to be expensed and gains related to previously held interests (step acquisitions) will have to be recognised in the profit or loss (these gains were previously recognised as a revaluation surplus in equity).
As a result, the wider use of fair value will increase the incentive for more accurate and reliable value assessments.
Such accurate and reliable value assessment can usually be achieved through detailed analyses of historical and projected financial statements. These analyses provide an insight into the determinants of the intangibles to be recognised and contribute to more reliable measurement.
Both market factors (e.g. market surveys, sector benchmarking reports) and company specific factors should be studied during this process. The application of specific and sometimes sophisticated valuation methods (Multi-period excess earning method, relief from royalty method to name a few) which include models to assess the probability of performance objectives being achieved may also increase accuracy.
The best way to avoid (bad) surprises (especially in the current market conditions where, for example, debt covenants play a crucial role) is to anticipate the consequences of the proposed transaction terms in the framework of the new accounting standard at an early stage (i.e. prior transaction date, during negotiations) and to model potential scenarios.
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