In December 2002 the International Accounting Standards Board published as part of its business combinations project an exposure draft of a proposed IFRS to replace IAS 22, Business Combinations (ED 3), and an ED of proposed changes to

IAS 36, Impairment of Assets, and IAS 38, Intangible Assets. The IASB announced in July 2001 that it would undertake a business combinations project as part of its initial agenda. The project's overall objective is to improve the quality of, and seek international convergence on, the accounting for business combinations and the subsequent accounting for goodwill and intangible assets acquired in business combinations.

The project has two phases. Phase 1 has resulted in the publication of ED 3 and the exposure draft of proposed changes to

IAS 36 and IAS 38. The comment deadline for these EDs is 4 April 2003.

Phase 2 of the project comprises three parts:

•   The application of the purchase method. This is being run as a joint project with the US Financial Accounting Standards Board.

•   The accounting for business combinations in which separate entities or operations of entities are brought together to form a joint venture, including possible applications for 'fresh start' accounting.

•   The accounting for business combinations involving entities under common control.

Proposed changes to replace IAS 22

Method of accounting for business combinations. IAS 22 permits business combinations to be accounted for using one of two methods: the pooling of interests method for combinations classified as unitings of interests and the purchase method for combinations classified as acquisitions. Consistent with the prohibition of the pooling of interests method in Australia, Canada and the US, ED 3 proposes that all business combinations within its scope should be accounted for using the purchase method.

Restructuring provisions. Under IAS 22, an acquirer must recognise as part of allocating the cost of a business combination a provision for terminating or reducing the activities of the acquiree (a 'restructuring provision') that was not a liability of the acquiree at the acquisition date, provided specified criteria are met. Those criteria differ from the criteria in

IAS 37, Provisions, Contingent Liabilities and Contingent Assets, for the recognition of restructuring provisions in the absence of a business combination.

ED 3 proposes to remove this inconsistency by requiring an acquirer to recognise a restructuring provision as part of allocating the cost of a combination only when the acquiree has, at the acquisition date, an existing liability for restructuring that would be recognised under

IAS 37.

Contingent liabilities. ED 3 proposes that an acquirer should recognise separately the acquiree's contingent liabilities at the acquisition date as part of allocating the cost of the combination, provided their fair values can be measured reliably. They should be measured after initial recognition at fair value.

Measuring the identifiable assets acquired and liabilities and contingent liabilities assumed. IAS 22 includes a benchmark and an allowed alternative treatment for the initial measurement of the identifiable net assets acquired in a business combination. ED 3 proposes to omit the option that exists in IAS 22 and to require the acquiree's identifiable assets, liabilities and contingent liabilities to be measured initially by the acquirer at their fair values at the acquisition date. This proposal is consistent with the allowed alternative treatment in IAS 22.

Goodwill. IAS 22 requires goodwill acquired in a business combination to be amortised on a systematic basis over the best estimate of its useful life. ED 3 would not permit goodwill to be amortised. Instead, goodwill would be tested for impairment annually, or more frequently if events or changes in circumstances indicate that it might be impaired, in accordance with

IAS 36.

Negative goodwill. IAS 22 uses the term 'negative goodwill' to refer to the excess over the cost of a combination of the acquirer's interest in the net fair value of the acquiree's identifiable assets and liabilities. IAS 22 effectively requires this excess to be recognised as a 'negative asset' in the balance sheet and 'released' to the income statement in future periods.

However, ED 3 proposes that when such an excess arises, the acquirer should:

•   reassess the identification and measurement of the acquiree's identifiable assets, liabilities and contingent liabilities and the measurement of the cost of the combination; and

•   recognise immediately in profit or loss any excess remaining after that reassessment.

Proposed changes to IAS 36

Measuring impairment losses for goodwill. If the carrying amount of a cash-generating unit to which goodwill has been allocated exceeds its recoverable amount,

IAS 36 requires the excess to be recognised as an impairment loss for goodwill. Any excess remaining after the carrying amount of goodwill has been reduced to zero is then recognised by being allocated to the other assets of the unit pro rata with their carrying amounts.

The ED proposes amending this approach. Instead of assuming that the impairment loss for the unit relates first to goodwill, the revised

IAS 36 would require an assessment to be made of the extent to which the impairment loss relates to the goodwill. This would involve comparing the carrying amount of the goodwill in the unit with its implied current value. The goodwill's implied current value would be measured consistently with the way that goodwill is measured in a business combination - the recoverable amount of the unit would be treated as though it were the 'purchase price', and the net fair value of the identifiable assets, liabilities and contingent liabilities of the unit on the date of the impairment test would be deducted from that amount.

Reversing impairment losses for goodwill.

IAS 36 requires an impairment loss for goodwill recognised in a previous reporting period to be reversed when that loss was caused by a specific external event of an exceptional nature that is not expected to recur and subsequent external events have occurred that reverse the effect of that event. The ED proposes to prohibit the recognition of reversals of impairment losses for goodwill.

Disclosure. The ED proposes requiring disclosure of a range of information for each segment that includes within its carrying amount goodwill or intangible assets with indefinite useful lives. That information is concerned primarily with:

•   the key assumptions used to measure the recoverable amounts of the cash-generating units in the segment that include within their carrying amounts goodwill or intangible assets with indefinite useful lives; and

•   the sensitivity of the recoverable amounts of those units to changes in the key assumptions.

Changes being proposed to IAS 38

Definition of an intangible asset.

IAS 38 defines an intangible asset as an identifiable non-monetary asset without physical substance held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. The ED proposes amending this definition by removing the requirement for the asset to be held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.

IAS 38 does not define ' identifiability', but states that an intangible asset can be distinguished clearly from goodwill if the asset is separable, but that separability is not a necessary condition for identifiability.

The ED proposes that an asset should be treated as meeting the identifiability criterion in the definition of an intangible asset when it: ! is separable, ie, capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or ! arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

Criteria for initial recognition.

IAS 38 requires an intangible asset to be recognised when it is probable that the future economic benefits attributable to the asset will flow to the entity, and its cost can be measured reliably.

The ED proposes additional guidance to clarify that the probability recognition criterion will always be satisfied for intangible assets acquired separately or in a business combination. The exposure draft also proposes clarifying that sufficient information should always exist to measure reliably the fair value of an intangible asset acquired in a business combination, unless the intangible asset is an assembled workforce.

Useful life.

IAS 38 includes a rebuttable presumption that the useful life of an intangible asset cannot exceed 20 years from the date the asset is available for use. The ED proposes:

•   to remove the rebuttable presumption; and

•   that an intangible asset should be treated as having an indefinite useful life when, based on an analysis of all relevant factors, there is no foreseeable limit on the period over which the asset is expected to generate net cash inflows for the entity.

An intangible asset with an indefinite useful life would not be amortised. Instead, it would be tested for impairment at the end of each annual reporting period, or more frequently if there is an indication that it may be impaired, in accordance with

IAS 36.

Annette Kimmitt is a senior project manager at the IASB.