A backlash is beginning to be felt throughout the auditing profession in Europe over proposed changes to accountancy rules covering combinations and mergers.Several non-governmental organizations, such as the European Federation of Accountants (FEE), the European Financial Advisory Group (EFRAG) - which represents a broader range of interest groups - and the Union of Industrial and Employers' Confederations of Europe (UNICE), are skeptical of what the International Accounting Standards Board has put forth in its proposal.

In June, the IASB published joint proposals to improve and align IFRS Section 3 from the new International Financial Reporting Standards. If the revisions, described by some as "radical," finally clear the hurdle of acceptance, they would become effective throughout the EU beginning Jan. 1, 2007.

A primary driver for the IFRS 3 revisions was to improve financial reporting by requiring the "acquisition method" to be applied to a greater range of business combinations. In future they would include true mergers, that is, combinations of mutual entities, plus those achieved by contract alone. The revision would require the acquiring body to recognize an acquiree at its full fair value, which would be measured at the acquisition date. Currently, acquired business is recognized at its accumulated cost.

However, the NGOs quickly point out that their objections are to the particular proposals, and in no way undermine their overall support for bringing IFRS and U.S. generally accepted accounting principles in line.

The exposure draft proposes that receivables (including loans) being acquired would also be measured at fair value. Therefore, the acquirer could no longer use separate valuations for unpaid debts. In addition, an identifiable asset or liability would be measured at fair value, even if the amount of the future benefits were contingent on the occurrence of one or more uncertain future events.

After recognition, such an asset would be accounted for under other sections of IFRS - IAS 38, Intangible Assets, or IAS 39, Financial Instruments: Recognition and Measurement.

Last year, the IASB had indicated that there would be future amendments to the present IFRS 3, which it then described as being in "interim" form. Early this summer, it issued an exposure draft of its proposals for the Phase II project. These are subject to comments to be submitted before Oct. 28, 2005.

Big Four firm Deloitte, in a special issue of its Web newsletter, expanded on details of the proposals. It noted that direct costs of the combination, which are currently included in the cost of acquisition, would be expensed as incurred. All of the acquiree's goodwill would be then recognized, even where less than 100 percent of the subsidiary were held.

Overall, the combinations project sets an important precedent. It demonstrates both the willingness and the ability of the IASB and of the U.S. Financial Accounting Standards Board to work together on relevant issues. It is pioneering in spirit, in the sense that there are currently several other projects being worked on by joint teams. However, if the path ahead for IFRS 3 looks rocky, in the U.S. the equivalent path is not likely to be much smoother.

The FEE expressed difficulties over the increased use of fair value. "This is an issue because fair value requires management's judgment when there is no active market," said the FEE's Catherine Ameye. She pointed out that "reliability of value is key for auditors. The difficulty gets worse with contingent assets or liabilities."

Meanwhile, EFRAG found proposals over recognition and measurement criteria to be not consistent with the existing conceptual framework of the IFRS, which came into effect in Europe on January 1 this year, and which is more principles-based than the U.S. GAAP rules.

An example of what EFRAG is referring to is the conjectured moving of the probability criterion from recognition to measurement. EFRAG believes that the "major changes in concepts should be discussed in the framework project first."

EFRAG maintained that the proposed changes would result in an increased use of fair value. "This requires in many circumstances a high degree of judgment ... where there is a lack of market information."

UNICE, an employer's organization representing millions of companies in Europe, confirmed that, indeed, European business has problems with the revision as well, primarily that the reaction-time constraint is too tight. In a letter, UNICE stated that the Phase II project "severely disrupts this course of improvement, raising again the deepest concerns that we have had in the past with the IASB in implementing fundamental changes to the underlying accounting concepts."

It believes that the current draft of amendments to IFRS 3 "ought to be frozen, pending the issue and discussion of the measurement issue." UNICE does, however, reaffirm its support for international convergence. Like EFRAG, it advocated "conceptual issues being raised first and standards being set after agreement on the concepts has been reached."

The IASB said that there was no intention in Phase II of introducing changes to accounting concepts. Rather, the new proposal should be viewed as a continuation of the work that started with IFRS 3, explained senior project manager Dr. Alan Teixeira.

The project seeks to apply concepts in the framework and not to change those concepts, Teixeira told Accounting Today. "Of course, the project proposed some important changes to the accounting for business combination in IFRS and U.S. GAAP. However, many of these changes arise from what the board believes is a more appropriate application of concepts in the framework."

"The principle of measuring the assets acquired and liabilities assumed in a business combination at the acquisition-date fair values was already embedded in the current version of IFRS 3," he said.

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