Peeling away financial reporting issues one layer at a time

The Revisions to IFRS 3: Bad Enough to Abandon Faith in IFRS?

In my previous post, I described how an SEC honcho, while speaking to the choir at an event sponsored by FEI, espoused his version of faith-based accounting; though he could not provide a single, solid reason to explain why the U.S. should adopt IFRS, he has seen the light and has become a true believer.   In contrast, reason-based accounting permits recitation of a vast litany of blasphemies against IFRS to make one a serious, if not committed, agnostic.  Today, I write of one of these latest abominations: the latest revision to IFRS 3 on the accounting for business combinations.

Goodwill and NCI:  IASB Fakes Right and Goes Left

Perhaps the most significant development in the accounting for business combinations is that FAS 141(R) now requires the same basis of measurement for assets acquired and liabilities assumed, regardless of the percentage of a company acquired (so long as control is achieved).  Therefore, if control is attained without purchasing 100% of the existing equity interests in the acquiree, non-controlling interests (NCI) must be measured at full fair value. 

As you may be aware from reading my post "What Good Comes from Goodwill Accounting?", I am not a big fan of recognizing 'goodwill' under any circumstance, so I will grant that the justification for the FASB's approach is not airtight.  Nevertheless, it was common knowledge that the FASB was given to understand that, by sticking its neck out to make these controversial changes to FAS 141(R), the IASB would follow suit. 

Instead, the IASB renegged on its promise in the worst way imaginable: they voted to allow entities a free choicebetween the partial and full fair value alternatives to goodwill and NCI measurement.  What's more, issuers can make their choice on a transaction-by-transaction basis — kind of like going to church one week and synagouge the next.  Not even the most devoted acolyte can spin this any other way except as a significant step backwards from establishing the IASB as a credible agent of quality financial reporting and investor protection. 

And, it's not just me who is outraged.  Read the strongly-worded dissents* of Mary Barth and John Smith, two of the three Americans on the IASB.  As to the third American, Jim Leisenring, I guess I shouldn't be surprised that he capitulated to the majority.  Leisenring was the most prominent voice in support of FAS 133 (on hedge accounting) when he was on the FASB; a standard whose middle name is inconsistency.  Be that as it may, one can only imagine where the IASB will take the interests of U.S. investors when our membership, and hence our influence, on IFRS inevitably wanes. 

Mind These GAAPs, Too 

If the unprincipled and unconstrained choice of accounting treatments for goodwill and NCI aren't enough for you to abandon any faith in a high-quality convergence, consider two more of the numerous departures from U.S. GAAP; these may be even worse.

First, the devilish game of managing the timing of contingent liabilities still thrives in IFRS.  FAS 141(R) now requires that any non-contractual, contingent liability assumed in a business combination must be recognized at fair value, if the probability of occurrence is more likely than not.  IFRS allows any contingent liability to be recognized, regardless of likelihood, if it can be reliably measured. 

As I discussed in a previous post on IASB machinations of contingent liability accounting, the ubiquitous criterion of "reliable measurement" is one of those areas of "judgement" in IFRS that help management make their numbers with little chance of being challenged by auditors.  Here is how this game will be played in a business combination under IFRS 3(R):  if management thinks that goodwill won't be impaired any time soon, they will recognize contingent liabilities to the max.  The effect is to create an earnings bank of liability writedowns when unlikely events become, as anticipated, resolved without the incurrence of an actual liability.  And speaking of inconsistency, IFRS 3(R) provides that all intangible assets are to be recognized, even if their fair values cannot be measured reliably.  Where is the "principle" for that one? 

Second, FAS 141(R) requires extensive disclosures that are designed to aid analysts in determining the past and future effect of a business combination on earnings and financial position.  For example, FAS 141(R) requires the following disclosures:

  • The amount of revenue and earnings of the acquiree since the date of acquisition. 
  • Revenue and earnings of the combined entity for the current period as though the acquisition had been consummated as of the beginning of the period
  • Revenue and earnings of the combined entity for the previous period, as if the acquisition had been consummated as of the beginning of the previous period. 

Inexplicably, IFRS does not require the third item, above.  Therefore, inferences as to earnings trends of the combined entity from historical financial statements are defeated.

The recent activities of the IASB, the high priests of IFRS, confirm that they are most definitely not the august body to which the future of U.S. financial accounting standards should be entrusted.  To those who persist in practicing faith-based accounting, put IFRS's accounting for business combinations in your pipe and smoke it.


*Unlike statements of the FASB, IFRS publications are not freely available.  Just thought you might want to know why I didn't provide a link.


  1. Reply David Merkel June 17, 2008

    I am not optimistic here. Unlike other value investors, though, I run a few accounting integrity checks on the accrual items. IFRS will make the accruals anomaly more intense, and those that don’t follow it closely will underperform.
    We should not adopt IFRS. Yes, it puts us on a common playing field, but by reducing transparency and increasing a management’s ability to smooth results, in the short run.

  2. Reply Independent Accountant June 17, 2008

    The Chris Cox (CC) SEC pushes IFRS accounting because Big Business wants IFRS accounting. The CC SEC is second worst I’ve encountered. I agree with you about SFAS 133 on hedge accounting: it makes no sense.
    So it goes.

  3. Reply guest June 19, 2008

    That’s a pretty unfair attack on Leisenring with no appropriate context regarding the background of FAS 133. The alternative to FAS 133 was virtually no recognition of derivatives in financial statements. Is it perfect? No. Were compromises made? Absolutely. But it was better than what was there before. And it certainly doesn’t indicate a pattern of Jim “capitulating to the majority.” If you’ve ever met Jim, then you know he’s not real concerned with what the majority thinks.
    You also should point out that Leisenring strongly dissented from a much more significant “option” that was put forth by the FASB–FAS 123. Considering that the FASB was being threatened with a shut down at that time, I’d say that is a pretty strong indicator of Jim’s independence.

  4. Reply Big4Guru June 19, 2008

    Why do I feel like I’m in “Atlas Shrugged?”

  5. Reply Big 4 Interview January 25, 2011

    Its really hard to form a solid opinion, I keep flip flopping but, overall I think its a much better set of standards when you consider the most important thing it brings: a more principle based approach. Exactly what we need, put the ball in the auditors court to enforce judgements with more professionalism rather than management making estimates and managing numbers to set benchmarks given o them in accounting literature…

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