Valuing intangibles under IFRS3

The last several years have seen an increased focus by companies on mergers and acquisitions as a means of stabilising their operations and increasing stakeholder value by achieving strategic expansion and cost reduction through business combinations.

Although such transactions can have significant benefits for an acquiring company, the related accounting is complex. IFRS 3 ‘Business Combinations’ (IFRS 3) requires an extensive analysis to be performed in order to accurately detect, recognise and measure at fair value the tangible and intangible assets and liabilities acquired in a business combination. Furthermore, the interaction of IFRS 3 with IFRS 10 ‘Consolidated Financial Statements’ (issued May 2011) and IFRS 13 ‘Fair Value Measurement’ (issued May 2011) means that this continues to be both a complex and a developing area of financial reporting.

The accounting for intangible assets acquired in a business combination is particularly challenging for a number of reasons. Intangible assets are by nature less detectable than tangible ones. Many are not recognised in the acquiree’s pre-combination financial statements. Determining their fair value usually involves estimation techniques as quoted prices are rarely available.
Where an ‘intangible resource’ is not recognised as an intangible asset, it is subsumed into goodwill. Some acquirers might be motivated to report fewer intangibles, and higher goodwill, because most intangible assets must be amortised whereas goodwill is measured under an impairment only approach. However, a high goodwill figure can create the impression that the acquirer overpaid for the acquired business. It also raises questions as to whether IFRS 3 has been applied correctly. Acquirers can expect reported amounts of intangible assets and goodwill to be closely scrutinised by investors, analysts and regulators.

Accounting for intangible assets in a business combination is therefore a sensitive area of financial reporting. Fortunately, Grant Thornton has extensive experience with business combinations and the related accounting requirements. Grant Thornton International Ltd (GTIL), through its IFRS team, develops general guidance that supports the Grant Thornton member firms’ (member firms) commitment to high quality, consistent application of IFRS. We are pleased to share these insights by publishing ‘Intangible Assets in a Business Combination’ (the Guide). The Guide reflects the collective efforts of GTIL’s IFRS team and the member firms’ IFRS experts and valuation specialists.

The Guide includes practical guidance on the detection of intangible assets in a business combination and also discusses the most common methods used in practice to estimate their fair value. It provides examples of intangible assets commonly found in business combinations and explains how they might be valued.

This Guide is organised as follows:
• Section A explains the general procedures necessary to detect intangible assets in a business combination. It outlines some of the strategies that are commonly used to detect acquired technologies, trademarks, and other resources that may meet the definition of identifiable intangible assets
in a business combination
• Section B explains fundamentals of fair value measurement as well as common methods to estimate the fair value of intangible assets. Key inputs for each method are identified and various examples further illustrate the issue
• Section C explains the characteristics of intangible assets that are frequently found in practice and common methods used to estimate their fair value. Factors that will usually impact their fair value measurement are also discussed
• Case Study.