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Making Acquisitions Transparent*An Evaluation of M&A-Related IFRS Disclosures by European Companies in 2005

Prof. Dr. Martin Glaum, Justus-Liebig-University GiessenProf. Donna L. Street, Ph.D., University of DaytonSilvia Vogel, Justus-Liebig-University Giessen

*connectedthinking FachverlagModerne Wirtschaft

Making Acquisitions Transparent An Evaluation of M&A-Related IFRS Disclosures by European Companies in 2005 Published by PricewaterhouseCoopers AG WPG, Frankfurt am Main Prof. Dr. Martin Glaum, Justus-Liebig-University Giessen Prof. Donna L. Street, Ph.D., University of Dayton. Silvia Vogel, Justus-Liebig-University Giessen ISBN 3-934803-28-8 Fachverlag Moderne Wirtschaft, Frankfurt am Main Protective charge 19,80 € © 2007 PricewaterhouseCoopers AG Wirtschaftsprüfungsgesellschaft All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherweise), without the prior written permission of both the copyright owner and the above publisher of this publication. Prepress PricewaterhouseCoopers, Frankfurt am Main/Berlin Press Fritz Schmitz Druck, Krefeld PricewaterhouseCoopers refers to the German firm PricewaterhouseCoopers AG Wirtschaftspruefungsgesellschaft and the other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. Printed in Germany PricewaterhouseCoopers is one of the leading auditing and consulting services networks worldwide and is drawing on the knowledge and skills of about 142,000 employees in 149 countries. In Germany, more than 8,100 employees generate a turnover of € 1.2 billion in assurance, tax and advisory services at 28 locations. For many years we have been auditing and consulting major companies of all sizes on the industrial and service sector. The service line “Middle Market”, attending directly to small and medium-sized companies with a solid network of local contacts, has been greatly expanded. And also the public sector, associations, municipal bodies and other organizations place their confidence in our knowledge and experience. For good reason: 380 partners and about 5,900 specialists impart their expertise to all important branches of industry. The commitment of these experts not only reflects the highest quality criteria in terms of their professionalism, but integrity, impartiality and objectivity are also part of the corporate philosophy. For this reason, great care is taken to offer clients only those all-in-one services that are consistent with the law – above all with the specific regulations for the American capital market. The most modern approaches are taken towards auditing, consulting and evaluation, thus supporting the companies in meeting the high demands of a competitive market. Our emphasis on high quality is complemented by forward thinking for our clients. This means going beyond the mere completion of a task and also anticipating their needs and providing a forward-looking solution. In doing so, we give our clients added security and help them succeed in world markets.

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Making Acquisitions Transparent - An Evaluation of M&A-Related IFRS Disclosures by European Companies in 2005

Preface

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Preface The adoption of International Financial Reporting Standards (IFRS) throughout Europe has significantly changed the way acquisitions are accounted for and how acquisitions are monitored on an ongoing basis. Under IFRS 3 “Business Combinations”, IAS 38 “Intangible Assets” and IAS 36 “Impairment of Assets” accounting for business combinations is now a boardroom issue, representing more or less a paradigm shift. These three international standards noteably represent the transformation from a traditional accounting framework to a more valuation-based framework. Thus, their application now requires deeper and sometimes very specific valuation knowledge.

Mergers and acquisitions represent major steps in the history of companies that become more relevant as the size and prominenance of the undertaken acquisition increases. A purchase price allocation (PPA) is performed for each acquisition whereby the purchase price is allocated to all tangible and intangible assets acquired and liabilities (including contingent liabilities) assumed, based on their respective fair values. The key challenge lies in the treatment of self-generated intangible assets of the acquired company because fair values must be estimated for each asset separately. Subsequent to the PPA, under the new standards, periodic goodwill amortisation is replaced by a goodwill impairment test that must be performed at least annually. The impairment test requires application of established procedures that again require specific valuation expertise.

Furthermore, more detailed disclosures in the financial statement footnotes are required in order to better inform investors, capital market participants and other stakeholders of the acquiring company. The increased transparency provides the market much greater insight regarding what has actually been acquired and whether the price paid – reflected in the remaining goodwill balance – can be justified in the future. Therefore, the market is able to judge the financial success or failure of acquisitions more quickly and accurately.

In 2005, the European Union’s exchange-listed companies were required for the first time to present consolidated financial statements in full compliance with IFRS as adopted by the EU. These companies had to meet this huge challenge of applying the respective merger accounting rules – in addition to all other IFRS standards – definitely representing more than a simple change to the financial presentation of M&A deals. Transparent cost allocation, rigorous impairment testing and enhanced disclosures for both the first-time consolidation and subsequently for impairment testing lead to increased attention being focused on acquisition accounting.

This PwC-sponsored study conducted by Prof. Martin Glaum, Prof. Donna L. Street and Silvia Vogel is the first comprehensive analysis of IFRS disclosures for business combinations and goodwill impairment testing. On a pan-European basis this empirical study investigates how the top-index listed companies in 17 countries dealt with the new merger accounting rules in 2005. This analysis is exclusively based on publicly available information provided in the companies’ disclosure footnotes. The overall aim of the standards addressed in “Making Acquisitions Transparent” has been challenged and interesting findings on first time application of the merger accounting rules is provided by the study.

Wolfgang Wagner Andreas Mackenstedt CEO PricewaterhouseCoopers PricewaterhouseCoopers Eurofirms CVBA Eurofirms Valuation & Strategy Leader


Table of contents

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Contents Preface..................................................................................................................................1

Figures ..................................................................................................................................3

Tables....................................................................................................................................5

Abbreviations ........................................................................................................................6

Executive Summary ..............................................................................................................7

A Introduction .....................................................................................................................10

B The Market for Mergers & Acquisitions (M&A) ...............................................................13

C Accounting and Disclosure for M&A Transactions .........................................................17

D M&A-Related Disclosures – Empirical Study .................................................................22

1 Methodology and Sample ...............................................................................................22

2 Acquisitions in 2005 ........................................................................................................26

3 Significance of Goodwill and Other Intangible Assets on Corporate Balance Sheets.............................................................................................................................39

4 Impairment Losses and Reversals of Impairment Losses for Goodwill and Other Intangible Assets ..................................................................................................43

5 Testing Goodwill for Impairment .....................................................................................47

E Summary and Conclusions.............................................................................................62

Literature .............................................................................................................................69

Contact ................................................................................................................................71


Figures

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Figures Fig. 1 Worldwide M&A transactions from 1995 to 2006: Transaction

volume .............................................................................................................14

Fig. 2 Worldwide M&A transactions from 1995 to 2006: Number of transactions .....................................................................................................14

Fig. 3 M&A transaction volume in European countries in 2005 ................................15

Fig. 4 European M&A transaction volume in 2005: Industry structure ......................16

Fig. 5 Number of sample companies by industry ......................................................23

Fig. 6 Average revenue per company by country in 2005.........................................24

Fig. 7 Average revenue per company by industry in 2005........................................25

Fig. 8 Average total assets per company by industry in 2005...................................25

Fig. 9 Average net income per company by country in 2005 ....................................26

Fig. 10 Average net income per company by industry in 2005 ...................................26

Fig. 11 Companies reporting acquisitions for financial year 2005...............................27

Fig. 12 Frequency of acquisitions (number of acquisitions per company) per industry in 2005 .........................................................................................28

Fig. 13 Frequency of acquisitions per country in 2005................................................28

Fig. 14 Materiality of acquisitions: Costs of individually reported transactions to companies’ total assets in 2005..............................................30

Fig. 15 Materiality of acquisitions: Costs of transactions reported in aggregate to companies’ total assets in 2005 .................................................30

Fig. 16 Purchase price allocation: Number of classes of assets acquired, and liabilities and contingent liabilities assumed in 2005 ................................33

Fig. 17 Purchase price allocation: Number of classes of intangible assets acquired in 2005 ..............................................................................................34

Fig. 18 Ratio of goodwill to cost of acquisition: Number of individually reported transactions in 2005 ..........................................................................37

Fig. 19 Ratio of goodwill to cost of acquisition: Number of aggregate sets of transactions .................................................................................................37

Fig. 20 Ratio of goodwill to cost of acquisition by industry ..........................................38

Fig. 21 Average goodwill and average intangibles (including goodwill) per company by country in 2005............................................................................40

Fig. 22 Average goodwill and average intangibles (including goodwill) per company by industry in 2005...........................................................................40

Fig. 23 Average percentage of goodwill relative to total equity per company by country in 2005............................................................................41


Figures

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Fig. 24 Average percentage of goodwill relative to total equity per company by industry in 2005...........................................................................42

Fig. 25 Number of companies recognising impairment losses in 2005.......................43

Fig. 26 Number of companies recognising goodwill impairment losses in 2005.................................................................................................................44

Fig. 27 Number of cash generating units disclosed as containing goodwill per company in 2005 .......................................................................................48

Fig. 28 Number of cash generating units disclosed as containing significant goodwill per company in 2005........................................................49

Fig. 29 Classification criteria for determining cash generating units in 2005.................................................................................................................50

Fig. 30 Basis for measurement of recoverable amount for goodwill impairment testing – Fair value less costs to sell versus value in use in 2005 ......................................................................................................52

Fig. 31 Methods used to estimate CGU fair values in 2005........................................53

Fig. 32 Application of value-in-use method: Planning period in 2005 .........................55

Fig. 33 Application of value-in-use method: Maximum reported long-term growth rates of expected cash flows in 2005 ..................................................57

Fig. 34 Application of value-in-use method: Minimum reported discount rates in 2005....................................................................................................59


Tables

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Tables Tab. 1 Sample composition (in alphabetical order) ....................................................12

Tab. 2 Sample selection .............................................................................................23

Tab. 3 Number of acquisitions reported per company in 2005...................................27

Tab. 4 Cost of acquisitions in 2005 (individually reported transactions only, in million €) ..............................................................................................29

Tab. 5 Goodwill resulting from 2005 acquisitions (individually reported transactions, in million €) .................................................................................35

Tab. 6 Goodwill resulting from 2005 acquisitions (transactions reported in aggregate, in million €) ....................................................................................36

Tab. 7 Impairment losses recognised for intangible assets by country in 2005.................................................................................................................45

Tab. 8 Impairment losses recognised for intangible assets by industry in 2005.................................................................................................................45

Tab. 9 Reversals of impairment losses recognised by country in 2005 .....................47

Tab. 10 Reversals of impairment losses recognised by industry in 2005 ....................47

Tab. 11 Disclosed timing of goodwill impairment testing in 2005.................................51


Abbreviations

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Abbreviations BC Basis of Conclusion

CGU Cash Generating Unit

DAI Deutsches Aktieninstitut e.V.

EBITDA Earnings before interest, taxes, depreciation and amortization

ED Exposure Draft

EFRAG European Financial Reporting Advisory Group

EU European Union

FASB Financial Accounting Standards Board (U.S.)

FEE Fédération des Experts Comptables Européens

GAAP Generally Accepted Accounting Principles

GDP Gross Domestic Product

IAS International Accounting Standards

IASB International Accounting Standards Board

IDW Institut der Wirtschaftsprüfer in Deutschland e.V.

IFRS International Financial Reporting Standards

M&A Mergers and Acquisitions

PPA Purchase Price Allocation

SFAS Statement of Financial Reporting Standard (U.S.)

U.K. United Kingdom

U.S. United States


Executive Summary

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Executive Summary Beginning in 2005, European Union (EU) exchange-listed companies were required to publish IFRS consolidated financial statements following the EU’s IFRS regulation from July 2002. Thus, several thousand companies migrated from their local GAAP and adopted IFRS for the first time – representing a major and indeed unprecedented economic experiment.

One of the most challenging areas within IFRS is “merger accounting”. The respective standards (IFRS 3 in combination with revised versions of IAS 36 and IAS 38) are relatively new, and have resulted in far reaching changes. Given the high relevance of merger accounting and the relative newness of the respective IFRS standards, there is currently some uncertainty among preparers and financial statement users as to the application and interpretation of these standards. This uncertainty provides the background and the motivation for this study.

Our aim is to ascertain how companies comprising the top-tier of Europe’s leading stock exchanges applied IFRS merger accounting in 2005. More precisely, we conduct an in-depth analysis and evaluation of companies’ disclosures related to acquisitions undertaken in 2005 as well as disclosures related to goodwill, other intangible assets and impairment testing. Starting with 461 companies from 17 European countries representing all industries, a sample of 357 blue-chip companies was subjected to our analyses. All sample companies reported consolidated financial statements in accordance with IFRS, undertook acquisitions in 2005 and/or carried goodwill positions and produced publicly available annual reports in the English language.

We stress that our findings should be considered in light of the fact that, for the majority of sample companies, 2005 represents their first year of full IFRS adoption. This paradigm shift, in most cases from their local GAAPs, represents a major hurdle. Of particular relevance, the new standard IFRS 3 and the revised versions of IAS 36 and IAS 38 were issued on 31 March 2004 and accordingly were relatively new thereby allowing very little time to prepare for their application in the 2005 consolidated financial statements.

Given these obstacles to implementing IFRS merger-related accounting rules, our analysis of the surveyed companies indicates a substantial achievement by the companies and should be applauded. Based on our detailed review of the financial statement footnotes, it appears that a majority of the leading European companies comprising our sample in general successfully navigated the application of IFRS merger accounting.

The findings of this study - solely taking into consideration selected IFRS standards dealing with merger accounting issues - must be interpreted as a snap shot for 2005, the first year of full IFRS adoption. Therefore, as one would expect, our analysis also uncovered areas for further improvement regarding the disclosures required by these standards.

Key findings regarding M&A disclosures include: ● In total more than 780 transactions are reported by approximately two-thirds of our

sample companies. Thereof nearly 300 transactions are reported individually, while the remaining transactions are reported in aggregate (i.e., representing approximately 100 sets). The average total acquisition cost for individually reported transactions is € 512 million. Interestingly, companies voluntarily enhance transparency as many individually reported acquisitions are relatively small; for a majority, acquisition costs represent less than 1% of post-acquisition total assets. However, a few companies aggregate disclosures for acquisitions where aggregate acquisition costs exceed 5% of post-acquisition assets.

● The vast majority of our sample companies disclose the cost of their acquisitions

(purchase price). However, one-third of the companies do not provide a description of


Executive Summary

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the components of the cost of the business combination, which should include “costs directly attributable to the combination”.

● Regarding purchase price allocation (PPA), about one-fourth of the companies do not

provide information regarding the classes of acquired assets, liabilities and contingent liabilities. In other instances, information on PPA is provided but is limited in content. In most instances, companies provide information for only one class of intangible assets. Contingent liabilities are rarely recognised as part of PPA.

● The great majority of acquisitions undertaken by our sample in 2005 led to the

recognition of goodwill. In most cases the values assigned to goodwill represent 50% or more of the total cost of the acquisitions. Only about 40% of the companies provide a rationale for the recognition of goodwill. Furthermore, those providing this disclosure in general only vaguely refer to expected synergy effects and growth expectations.

● Less than one-quarter of the companies provide acquisition-related pro-forma

disclosures. Furthermore, very few of the companies not disclosing pro-forma information refer to this fact and explain why supplying these disclosures is impracticable.

Key findings regarding goodwill and other intangible assets include: ● The average total intangibles balance is € 3.8 billion, with a substantial portion – € 2.5

billion – being attributable to goodwill. ● Approximately 20% of our sample companies report intangible assets assigned indefinite

useful lives (other than goodwill) on their balance sheets or provide detailed disclosure in their notes. The average balance is € 0.8 billion.

● Goodwill balances, on average, represent approximately 40% of total shareholders’

equity. For some companies, goodwill even exceeds equity. Thus, a significant number of sample companies appear very vulnerable to potential future goodwill impairment charges.

Key findings regarding impairment charges recognised in 2005 include: ● Approximately 70% of the companies report impairment losses. About one-third

recognise impairment charges associated with goodwill; for these companies, the average charge to net income is € 358 million.

● The number of companies reporting impairment of intangible assets with definite lives is

similar to that reporting goodwill impairment. However, the average loss is much lower at € 38 million.

● Impairment of intangible assets assigned indefinite lives is a rather rare occurrence. Our overall results regarding goodwill impairment testing include: ● About two-thirds of the companies with goodwill balances voluntarily disclose the total

number of cash-generating units (CGUs) containing goodwill. For most companies, goodwill is concentrated in a small number of CGUs. Most allocate goodwill to CGUs utilising the highest hierarchical level allowed by IFRS, i.e., the primary or secondary segment reporting format.

● Most sample companies perform the required annual goodwill impairment test at, or

shortly before, the balance sheet date. None of the companies explicitly indicate that additional impairment testing was conducted during 2005 in response to triggering events.

● Over 80% of the companies with goodwill balances disclose the method used to

measure the recoverable amount of CGUs for which the carrying amount of goodwill is significant. Most of these utilise the value-in-use concept either exclusively (68%) or in


Executive Summary

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conjunction with fair value less costs to sell (11%). A majority of these companies provides all required IFRS disclosures with respect to value-in-use estimations for CGUs containing significant goodwill. However, a significant number do not provide all the prescribed disclosures, and some do not provide any.

● For companies employing the value-in-use concept to determine the recoverable amount

of CGUs containing significant goodwill, the cash-flow planning horizon varies greatly, not only between companies but also within companies for different CGUs. The same holds true for the growth rates underlying the calculations of terminal values and the discount rates applied in the valuations. For example, for the (minimum) discount rates a wide span of rates is used, ranging from 4% to 34%, with high proportions of companies employing rates between 7% and 9%.

● While some companies precisely disclose key parameters per CGU, others only provide

summary ranges of planning periods, growth rates and discount rates. ● Very few companies with goodwill balances disclose sensitivity tests including the

amounts by which key assumptions need to change for a CGU’s recoverable amount to equal its carrying amount.

Despite the fact that the sample companies achieved an observable level of compliance with many of the merger accounting disclosure requirements, our analysis also uncovered areas where for a substantial number of companies improvement is feasible.

Taking the outcomes from our study into consideration, we now highlight three avenues for future improvements in the application of IFRS merger accounting and disclosure: ● We believe that the top-tier companies of Europe’s leading stock exchanges should set

the benchmark for high-quality financial reporting that other companies across Europe should be encouraged to follow. Our analysis reveals that many of our sample companies have accepted this challenge. However, others still have a way to go to comply fully with IFRS merger-related disclosures.

● Many companies can enhance transparency and comparability by improving the

understandability and information content of existing IFRS disclosures. We anticipate that given the high relevance of merger accounting and goodwill-related disclosures such efforts directed at improving the understandability and information content of existing IFRS disclosures will be well received by investors, analysts and other financial statement users.

● We encourage the IASB to consider providing moderate clarification of a few select

areas of merger-related accounting and disclosure to further advance comparability. Concurrently, we suggest that the IASB consider dispensing of a few disclosure requirements that in practice are found as having an unfavorable cost-benefit relationship. This could potentially ease the challenge of IFRS application and accordingly enhance understandability and comparability.

In conclusion, the primary responsibility for enhancing the transparency of merger-related disclosures falls to financial statement preparers, with the assistance of auditors, consultants, analysts and academics to develop best practice guidance of IFRS requirements for the issues highlighted in our report. Best practices should facilitate consistent and comparable accounting between entities which is in the best interest of investors, analysts and other financial statement users. Furthermore, given the complexity and the costs involved in applying current accounting and disclosure regulations, companies using IFRS themselves should have a strong incentive to facilitate and advance such learning processes.


Introduction

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A Introduction As of 2005, more than 7,000 exchange-listed companies in the European Union (EU) adopted International Financial Reporting Standards (IFRS) for their consolidated financial statements because of the European Union’s IAS/IFRS regulation from July 2002 (EU Regulation No. 1606/2002).1 The adoption of IFRS represents a major challenge for many of these companies. This particularly holds true for Continental-European companies because IFRS is strongly influenced by Anglo-American accounting and, therefore, differs greatly from Continental European accounting, both in terms of its overall philosophy (objectives, framework, etc.) as well as including more detailed accounting rules.

One of the most challenging – and most controversial – areas of IFRS accounting is “merger accounting” (i.e., the rules companies apply in their consolidated financial statements when they acquire, or merge with, other companies). The respective standards addressing merger accounting are IFRS 3 “Business Combinations”, IAS 36 “Impairment of Assets” and IAS 38 “Intangible Assets”. IFRS 3 is a relatively new standard released by the International Accounting Standards Board (IASB) in March 2004.2 Concurrently, the IASB published revised versions of IAS 36 and IAS 38. With IFRS 3 and the revised IAS 36 and IAS 38, the IASB introduced far reaching and important changes:

● For companies already using IFRS, all acquisitions effected on or after the 31st of March 2004, must be accounted for using the purchase method. Companies adopting IFRS for the first time in 2005 are required to apply the rules as of the date of their transition, that is, from the date of their 2004 IFRS opening balance sheet.

● The pooling-of-interest method, that previously had to be applied under certain

conditions as an alternative method, is abolished. ● Furthermore, the rules for the recognition of intangible assets acquired in the context of

business combinations were changed so that companies now are required to recognise a much wider range of intangible assets, many of which were previously subsumed in goodwill.

● Finally, the goodwill resulting from acquisitions cannot be amortised. Instead, companies

are required to test goodwill at least annually for impairment (impairment-only approach), following a very demanding and onerous impairment test procedure.3 This means that the previously predictable annual amortisation charge for goodwill is replaced by the danger of sudden substantial impairment losses. As a result, earnings may be more volatile. Furthermore, management must be aware that impairment losses related to goodwill can evoke serious doubts about the logic of the respective merger and acquisition (M&A) transactions and the skills of the managers responsible for them.4

1 Thousands of companies outside Europe are also migrating from their respective local Generally Accepted Accounting Principles (GAAP) to IFRS. For example, IFRS is currently required, or will be required from 2007 onward, for all domestic listed companies in Australia, New Zealand, Kenya, Hong Kong, Kazakhstan, South Africa, the Philippines, Costa Rica, and in many other countries in Eastern Europe, Asia, Africa, and South America. For details, see PwC (2005), World Watch, Issue 2/2005. 2 Although IFRS 3 is relatively new, by October 2005 the IASB had already issued an exposure draft (ED) proposing revisions to the standard. The principle change proposed by ED IFRS 3 is the introduction of the so-called full-goodwill method. 3 These changes followed similar changes in the U.S. where the FASB issued SFAS 141 “Business Combinations” and SFAS 142 “Goodwill and Other Intangible Assets” in June 2001. 4 A study by Hirschey and Richardson (2003) shows that the stock market typically reacts negatively to news about goodwill impairment. The immediate impact on companies’ stock prices was, on average, -3.0 to -3.5%. However, many stocks experienced serious further negative returns in the months after the announcement. On average, the overall effect during the one-year post-announcement period was -11.02%. Thus, even though goodwill impairments do not have direct cash implications, they can be interpreted as (negative) signals about the value of companies’ intangibles and about their future earnings potential. For details, see Hirschey M. / Richardson V. J. (2003), Investor Underreaction to Goodwill Write Offs, in: Financial Analysts Journal, November/December, pp. 75-84.

As of 2005, more than 7,000 exchange-listed companies in the EU adopted IFRS.


Introduction

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Acquisitions – The Need for Transparency The IASB believes the purchase method - combined with extensive new disclosure rules regarding the cost of acquisitions and the values of the assets and liabilities recognised - will improve transparency. The Board hopes analysts and other market participants will be able to more rapidly and accurately assess the financial impact of business combinations. Thus, with the new rules, the IASB wants to strengthen the accountability function of accounting with respect to M&A transactions.5

First, acquisitions are investments that often involve large sums of money. Thus, these transactions are of strategic importance because of their relevance to firm value. Second, many survey studies undertaken by consulting firms as well as academic research in the areas of industrial economics and corporate finance find that a high percentage of M&A transactions fail to meet their operational and financial goals.6 This amplifies the importance investors and analysts attach to transparent merger accounting and disclosure rules.

Demands on Companies’ Management and Systems Complying with the new IFRS merger accounting and disclosure rules places great demands on companies’ management and systems. For instance, under the purchase method, the acquiring company is required to recognise all assets acquired and liabilities assumed, including many that have not previously been recognised by the acquiree. In this context, companies need to identify and value a wide range of intangible assets. IFRS also requires companies to recognise contingent liabilities assumed in the course of acquisitions. The idenification and valuation of such liabilities can also be highly challenging in practice. To perform goodwill impairment tests, companies regularly need to value their operational business units on the basis of forward-looking information (business plans, etc.). This requires a systematic integration of accounting with the planning and controlling functions of the companies. Furthermore, companies need to develop or acquire valuation competencies, that is, highly specialised corporate finance expertise that was not required in traditional accounting departments.

IFRS Merger Accounting – Uncertainty and Demand for “Best Practice” Given that thousands of companies across Europe were required to apply IFRS for the first time in 2005, and given the relative newness of the respective standards, there is currently uncertainty among practitioners with regard to the application of IFRS 3, IAS 36 and IAS 38. Companies’ managements are demanding guidance on specific questions and problems, and they are interested in information about “best practice”. Similarly, there is uncertainty among investors, analysts, banks, supervisory authorities, regulatory bodies and other users as to how companies actually apply the IFRS merger accounting standards. They want to know whether companies are in compliance with the rules, how they interpret the rules and the degree of reliability of the information provided in the financial statements regarding M&A.

Study Design and Sample The wide-spread uncertainty about the application of IFRS merger accounting standards serves as the primary motivation for our study that provides a comprehensive assessment of the 2005 M&A-related financial statement disclosures of companies comprising the

5 See IFRS 3 (BC 45). 6 For a comprehensive survey of this literature, see Sudarsanam, S. (2003), Creating Value from Mergers and Acquisitions: The Challenges.

The wide-spread uncertainty about the application of IFRS merger accounting standards serves as the primary motivation for our study that provides a comprehensive assessment of the 2005 M&A-related financial statement disclosures of major European companies.


Introduction

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premium segments of the major European stock exchanges. More precisely, we analyse and comment on the companies’ transaction related disclosures as well as their disclosures related to goodwill and other intangible assets and impairment testing. Areas of specific interest include the disclosures regarding purchase price allocation following acquisitions, in particular the allocation of goodwill to cash generating units, and the key assumptions underlying the annual impairment reviews of goodwill.

Countries Stock Market Indices Number of companies analysed Austria ATX 16

Belgium BEL 20 16 Czech Republic PX Index 6

Denmark OMXC 20 14 Finland OMXH 25 21 France CAC 40 34

Germany DAX 30 21 Hungary BUX 6

Ireland ISEQ 20 14 Italy S&P / MIP 33

Luxembourg LuxX 4 Netherlands AEX 18

Poland WIG 20 13 Spain IBEX 35 28

Sweden OMXS 30 20 Switzerland SMI 18

United Kingdom FTSE 100 75 Total number of companies analysed: 357

Tab. 1 Sample composition (in alphabetical order)

Our sample is comprised of the top stock market indices of 17 European countries (see Table 1). The companies included in these stock market indices are the most important exchange-listed European companies; many of them rank among the largest companies in the world. Companies without acquisitions in 2005 and without goodwill on their balance sheets are excluded from the analysis. Further, we exclude U.S.-listed companies that publish U.S.-GAAP financial statements and hence were not required to prepare IFRS consolidated financials in 2005, companies with balance-sheet dates later than 30 March 2006 and companies for which we were unable to obtain English-language financial reports. Our final sample is comprised of 357 companies7.

Structure of Report The structure of the report is as follows. In part B, we give a brief overview of the development of the market for M&A in recent years. In part C, we summarise the IFRS accounting and disclosure rules for business combinations. In this context, we highlight the most important changes brought about by IFRS 3, IAS 36 and IAS 38 and point out some further critical issues currently being debated across Europe as well as in other parts of the world. Part D is devoted to our empirical study. We first describe the sample and the methodology utilised. We then present and discuss the findings of our analysis. The main areas covered in the analysis are the companies’ 2005 acquisitions and the respective purchase price allocations, the companies’ disclosures regarding goodwill and other intangible assets and the disclosures regarding impairment testing of goodwill. The report concludes with a short summary.

7 More details on the sample selection process and on the sample composition are provided in section D.1 of this report.

Our sample consists of 357 companies comprising the top stock market indices of 17 European countries.


The Market for Mergers & Acquisitions (M&A)

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B The Market for Mergers & Acquisitions (M&A) Acquisitions are a cyclical phenomenon. Even though the mechanism is not yet fully understood, a possible explanation for the occurrence of “merger waves” is that economic, technological or regulatory changes lead to restructuring of industries or economies. Other explanations are based on the observation that the level of M&A activity appears to be closely associated with the valuation of companies in the stock market. This association could result from a high number of takeovers contributing to an increase in the valuation of stocks. Alternatively, high valuations may induce the management of companies to use highly valued stocks as “takeover currency”.8

In the second half of the 1990s, the number and volume of worldwide acquisitions grew very strongly. As illustrated in Figures 1 and 2, transaction volume increased over-proportionally, implying a rise in the average size of the transactions. This growth was fuelled by numerous “mega-deals” that occurred primarily in the telecommunications, pharmaceutical, oil and banking industries.9 The highest annual transaction volume was recorded in 2000, at the height of the high-tech bubble in the equity markets, with a total worldwide volume of € 3,691.2 billion. In the following years, the number and especially the volume of M&A transactions fell dramatically, parallel to the decrease of valuations in the stock markets. In 2003, total worldwide transaction volume was down to only € 1,093.1 billion, less than one third of the volume in the year 2000.

In more recent years, however, the markets have recovered, and acquisitions are again viewed as an important instrument for corporate growth. Recent M&A activity has been especially lively in Europe. From a target company’s perspective, acquisition volume in Europe from 1998 to 2000 accounted for 32% of total worldwide acquisitions. By 2005, the European share of the world market for M&A increased to 40%. Over the same time period, the U.S. market share decreased from almost 60% in the period from 1998 to 2000 to “only” 45%.

Several reasons may explain the over-proportional growth of M&A in Europe in recent years. Some European markets have been liberalised relatively recently (e.g., telecommunications, energy and postal services), thereby, leading to increased takeover activity. In many European markets, on-going consolidation processes take place. In other words, European companies acquire, or merge with, other companies to achieve the scales needed for survival in integrated European or global markets. Another contributing factor is the efforts of large and often highly diversified European companies to restructure, particularly to reduce their degree of diversification and integration. These diversified companies are selling off non-core business units and, at the same time, undertaking acquisitions to strengthen their core business. Furthermore, especially in Continental European countries, an increasing number of M&A transactions involve family-owned, medium-sized companies. These acquisitions often occur in connection with generation changes and succession problems. Finally, since the second half of the 1990s, private equity investors, following a phenomenon previously occurring mainly in the U.S., have “discovered” Europe. For instance, estimates suggest that in 2003, 12% of all European M&A investments were undertaken by private equity investors (the corresponding figure for the year 2000 was only 4%). In 2004, about 7,000 European companies received private equity and venture capital. Investments by European private equity and venture capital funds amounted to € 36.9 billion.10 More recently, inflows to

8 See Hartford, J. (2005), What drives merger waves?, in: Journal of Financial Economics, Vol. 77, September, pp. 529-560, for an overview of the literature on merger waves. 9 Ten of the 20 largest acquisitions occurring between 1995 and 2000 were in the telecommunications industry. Most of these took place in the U.S. However, the largest deal was the takeover of Mannesmann by Vodafone in 1999/2000, with a volume of € 189.7 billion (source of data: Thomson Financial). 10 See Achleitner, A. K. / Klöckner, O. (2005), Employment contribution of private equity and venture capital in Europe, Research Paper, Private Equity and Venture Capital Association.

In recent years, M&A markets have recovered, and acquisitions are again viewed as an important instrument for corporate growth. Recent M&A activity has been especially lively in Europe.



14

private equity funds have further increased. As a result, private equity funds today have the financial strength to undertake so-called “mega deals” with volumes of several billion Euros.

180 229 341599

863

1,543

746530 417 384

641 617356510

690

1,2331,146

1,758

1,291

685492 712

761 976

3690

81

62113

360

308

174

154157

257224

9

12

18

3833

30

19

25

3036

4959

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*

Volu

me

in b

illio

n €

Europe America Asia Other*01.01.2006 - 30.09.2006Source: Thomson Financial

Fig. 1 Worldwide M&A transactions from 1995 to 2006: Transaction volume

7,416 6,870 7,520 8,35811,311 12,950

10,2047,561 7,106 7,034 7,731 7,099

9,262 10,737 11,85813,482

11,87111,931

8,6287,873 8,046 9,220 9,421 9,247

1,826 2,2842,404

2,4073,238

3,986

3,792

3,937 5,1735,851 6,142

4,879526

571796

968945

879

706

594 758708 789

713

0

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10,000

15,000

20,000

25,000

30,000

35,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*

Num

ber o

f tra

nsac

tions

Europe America Asia Other *01.01.2006 - 30.09.2006Source: Thomson Financial

Fig. 2 Worldwide M&A transactions from 1995 to 2006: Number of transactions

Figure 3 shows the distribution of M&A transactions in European countries for the year 2005 from the perspective of the acquiring companies. The transaction volume is presented in detail for the 17 countries represented in our empirical study. According to the Thomson Financial M&A database, these 17 countries in 2005 accounted for a total transaction volume of € 615 billion, or 95% of all European M&A. The U.K. has been by far the most important market for acquisitions, with a volume of € 163 billion. This is almost twice the volume of The Netherlands (€ 91 billion), the next-biggest national European M&A market in 2005.11 The next largest markets for M&A in 2005 were France (€ 84

11 The U.K. traditionally has a very active M&A market that may be linked to its highly developed and open capital markets. The U.K. stock market is by far the largest in Europe. For instance, it is much bigger than the German stock market, in absolute and even more so in relative terms. At the end of 2005, 2,757 domestic companies were listed in the U.K. (including Ireland), with a total market capitalisation of U.S.-$ 3,058.2 billion. In comparison, only 648 domestic companies were listed on the Frankfurt

In 2005, the 17 countries represented in our sample accounted for a total transaction volume of € 615 billion, or 95% of all European M&A.



15

billion), Italy (€ 80 billion) and Germany (€ 51 billion). M&A activity is much less strong in Scandinavian and Eastern European countries.

Finally, it is important to note that the data depicted in Figure 3 is for one year and that yearly data on M&A can be strongly influenced by large individual transactions. For instance, the volume of acquisitions by Dutch companies was unusually high in 2005 due to several large transactions in the energy sector. In fact, the volume of transactions by Dutch energy companies alone (€ 63.0 billion) accounts for almost 70% of all Dutch M&A transactions in this year.

Figure 4 presents the industry structure of European M&A activity in 2005. The industry with the highest level of M&A activity was the financial services industry with a total transaction volume of € 238.1 billion. More than a third of this volume is accounted for by acquisitions of U.K. financial services companies (€ 78.7 billion). Other countries with high transaction volumes in the financial services industry were Italy (€ 37.0 billion) and France (€ 33.4 billion). The second most active sector was the energy sector with a total volume of € 112 billion; about half of this volume is due to the aforementioned large transactions by Dutch companies. Other sectors with high M&A volumes in 2005 include telecommunications, basic materials and real estate.

Finally, average deal size varies greatly between different industries. For instance, the average transaction value of acquisitions in the energy sector and the telecommunications industry in 2005 was € 370 million and € 346 million, respectively. The information technology, consumer products services, and retailing sectors represent the other end of the spectrum where average prices were only € 15 million, € 23 million and € 26 million, respectively.

1

2

5

6

8

14

14

19

19

24

34

51

80

84

91

163

0

29

0 20 40 60 80 100 120 140 160 180

Others

Hungary

Czech Republic

Poland

Austria

Ireland

Luxembourg

Finland

Denmark

Sweden

Switzerland

Belgium

Spain

Germany

Italy

France

Netherlands

United Kingdom

Volume in billion €

Fig. 3 M&A transaction volume in European countries in 2005

Stock Exchange, with a total capitalisation of U.S.-$ 1,221.1 billion (year-end 2005). Based on the 2005 data, the ratio of total market capitalisation of domestic companies to GDP for the U.K. is 139.1% while it is only 43.7% for Germany. See Deutsches Aktieninstitut (2006), DAI Factbook 2006.

From an industry perspective in 2005, the financial services industry had the highest level of M&A activity with a total transaction volume of € 238 billion. More than a third of this volume is accounted for by acquisitions of U.K. financial services companies.



16

10

15

15

17

17

23

38

56

62

112

238

5

5

0 50 100 150 200 250

Government & Agencies

Retail

Information Technology

Pharmaceuticals

Consumer Products & Services

Agriculture

Entertainment & Media

Industrial Products

Real Estate

Basic Materials

Telecommunications

Energy & Power

Financials

Volume in billion €Source: Thomson Financial

Fig. 4 European M&A transaction volume in 2005: Industry structure


Accounting and Disclosure for M&A Transactions

17

C Accounting and Disclosure for M&A Transactions Throughout Europe IFRS 3 together with the revised versions of IAS 36 and IAS 38 have established significant and far reaching changes to accounting for business combinations. All acquisitions are now accounted for using the purchase (acquisition) method. The IASB believes the purchase method combined with new disclosures regarding the cost of acquisitions and the values of the assets and liabilities recognised improve transparency and provide users with relevant information about business combinations. Increased transparency provides the market with greater insight into what has actually been acquired, and analysts and other market participants are able to more rapidly and accurately assess the financial success or failure of business combinations. However, providing the new disclosures requires companies to follow a significantly more detailed and onerous analysis and valuation process.

The Purchase Method Under the purchase method, the acquiring company “recognises the assets acquired and the liabilities and contingent liabilities assumed, including those not previously recognised by the acquiree”.12 In other words, the purchase method simulates an “asset deal”. The acquirer presents the acquisition in its consolidated financial statements as if the individual assets (and assumed liabilities) of the target company had been acquired instead of shares in the acquired company’s legal shell. Therefore, as a first step, all assets and liabilities, including intangible assets and contingent liabilities, of the acquired entity must be identified and valued. In a second step, the purchase price is then allocated to the fair values of the assets acquired and liabilities and contingent liabilities assumed (purchase price allocation). Any residual is allocated to goodwill.13

Purchase price allocation is now more rigorous. For example, many intangibles that were previously included in goodwill (i.e., brands, customer relationships, technology etc.) must be individually identified separate from goodwill and valued if they are separable from the company or if they are based on contractual or legal rights.14 Therefore, appropriate valuation methods need to be applied in the estimation of the fair values of all identified intangible asset. These may be categorised as market approaches (e.g., valuations based on multiples), income approaches (e.g., relief-from-royalty method, multi-period excess earnings method and incremental cash flow method) and the cost approach (e.g., replacement cost approach and reproduction cost approach). The valuation of intangibles is often highly complex and may require specialist skills.15

Contingent Liabilities Contingent liabilities are either possible obligations whose existence depends on uncertain future events or existing obligations that cannot be measured with sufficient reliability or where it is not probable that the company will have to make payments to settle the obligation. According to IAS 37, companies normally are not allowed to recognise

12 See IFRS 3 (para. 15). 13 In reality, deferred taxes must be considered when computing the amount assigned to goodwill. The general rules for the recognition of deferred taxes in the context of accounting for business combinations are as follows: Companies are required to recognise deferred tax liabilities whenever the fair value of assets acquired (liabilities assumed) at the acquisition date are higher (lower) than the corresponding book values in the balance sheet of the acquiree. If, on the other hand, the fair value of assets (liabilities) acquired are lower (higher), the company recognises tax assets. The recognised deferred tax liabilities (assets) increase (decrease) the amounts assigned to goodwill. For details, see IAS 12 (paras. 66 to 68). 14 For details, see IFRS 3, Illustrative Examples. 15 For details, see Mackenstedt, A. / Fladung, H.-D. / Himmel, H. (2006), Ausgewählte Aspekte bei der Bestimmung beizule-gender Zeitwerte nach IFRS 3 – Anmerkungen zu IDW RS HFA 16 –, in: Die Wirtschaftsprüfung, Vol. 59, No. 16, pp. 1037-1048; Jäger, R. / Himmel, H. (2003), Die Fair Value-Bewertung immaterieller Vermögenswerte vor dem Hintergrund der Umsetzung internationaler Rechnungslegungsstandards, in: Betriebswirtschaftliche Forschung und Praxis, No. 4, pp. 417-440.

Throughout Europe IFRS 3 together with the revised versions of IAS 36 and IAS 38 have established significant and far reaching changes to accounting for business combinations.



18

contingent liabilities. However, as an exception, IFRS 3 requires that contingent liabilities that a company assumes in the context of an acquisition be recognised at fair value if they can be measured reliably.16 Accordingly, acquired contingent liabilities are now more visible. Furthermore, a consequence of the recognition of contingent liabilities is that the value assigned to goodwill increases, thereby, increasing the risk of impairment.

IFRS 3 Summary

The purchase method of accounting must be used. Recognition of more intangible assets and contingent liabilities required at acquisition date. Goodwill and other intangible assets with indefinite lives are not amortised but must be tested for impairment at least annually. Negative goodwill is recognised as a gain in the profit and loss statement immediately. Detailed disclosures about transactions and impairment testing are required.

Goodwill and Other Intangibles with Indefinite Useful Lives Under purchase accounting, a significant item often appearing on a company’s balance sheet following an acquisition is goodwill. In principle, goodwill is the excess of the purchase price over the fair value of the identifiable assets acquired less the liabilities assumed (taking into account deferred taxes). Economically speaking, goodwill represents going-concern elements as well as the growth and synergy expectations embodied in the purchase price of M&A transactions.

Under the new standards, intangible assets may now be assigned indefinite useful lives if there is no foreseeable limit on the period over which the asset will generate cash flows for the entity. For example, this may be the case for brand names acquired in the course of acquisitions.

Goodwill and other intangibles assigned indefinite useful lives are not amortised. Instead, goodwill and other indefinite lived intangibles must be reviewed at least annually to determine whether they have maintained their value. This annual impairment test may be performed at any time during the year, provided it is conducted at the same time every year. In addition to the obligatory annual review, goodwill and other indefinite lived intangibles must be tested whenever there is an indication that their value might be impaired (i.e., a triggering event occurs).

If the impairment test reveals that the carrying amount exceeds the recoverable amount, an impairment charge is immediately recognised in profit and loss. Thus, the previously predictable annual amortisation charge for goodwill is replaced by the potential danger of sudden substantial impairment losses. As a result, earnings may be more volatile. Furthermore, management must be aware that impairment losses related to goodwill can raise serious doubts about the logic of the respective M&A transactions. Similarly, the advantages of assigning an indefinite life to certain other intangibles must be carefully weighed against the potential disadvantage of a later impairment charge. Specialist skills may again be required to conduct these impairment reviews.

16 See IFRS 3 (para. 47).

Under the new IFRS rules, goodwill and other intangibles assigned indefinite useful lives are not amortised. Instead, they must be reviewed at least annually to determine whether they have maintained their value.



19

Testing Goodwill for Impairment and Definition of Cash Generating Units Testing assets for impairment involves a comparison of their carrying amount with their recoverable amount. The recoverable amount is defined as the higher of the asset’s fair value less costs to sell and its value in use (i.e., the present value of the expected future cash flows generated by the internal use of the asset).17 However, goodwill does not generate cash inflows independently of other assets or groups of assets. Additionally, goodwill cannot be separated from the company and sold in the market. Therefore, its recoverable amount cannot be determined in isolation.

For this reason, goodwill cannot be separately tested for impairment. Instead, at the time of the acquisition, goodwill is allocated to the Cash Generating Units (CGUs) of the combined company that are expected to benefit from the growth opportunities and the synergies of the business combination from which goodwill arose. CGUs represent groups of assets “that generate cash inflows that are largely independent of the cash inflows from other assets or groups of assets”.18 More precisely, goodwill must be allocated to the lowest organisational level within the company at which goodwill is monitored for internal management purposes.19 The level cannot be larger than the company’s primary or secondary segment reporting format.20

If the recoverable amount of a CGU exceeds its carrying amount, the unit and any goodwill allocated to the unit are not impaired. If, however, the carrying value of the CGU exceeds its recoverable amount, the excess is first recognised as an impairment loss for goodwill. If the impairment loss exceeds the carrying amount of the goodwill, the excess is allocated pro rata to the other assets of the CGU based on their carrying amounts.21 Impairment losses for goodwill cannot be reversed in subsequent periods.

Negative Goodwill The IASB doubts whether “bargain” purchases actually exist. Thus, negative goodwill (“badwill”) is now officially referred to as the “excess of acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over cost”.22 Any such excess left, after a reconsideration of the purchase accounting, is recognised immediately as a gain in the profit and loss statement.

Expanded Disclosures To assist users in understanding the financial consequences of transactions, the disclosure requirements for business combinations are significantly greater under the new IASB standards. These extensive disclosures are intended to enhance transparency and provide users with a clear understanding of the reasonableness of the calculations and their impact on the financial statements. Required disclosures include:

● details of the actual costs of an acquisition, ● details regarding the fair values assigned to assets and liabilities, ● an explanation of the amount assigned to goodwill,

17 See IAS 36 (para. 6). 18 See IAS 36 (para. 6). 19 See IAS 36 (para. 80 (a)). 20 See IAS 36 (para. 80 (b)). 21 See IAS 36 (para. 104) for further guidance. 22 See IFRS 3 (para. 56).

To assist users in understanding the financial consequences of transactions, the disclosure requirements for business combinations are significantly greater under the new IASB standards.



20

● the previous IFRS book value of acquired assets and liabilities to enable a comparison with fair values.

Detailed, onerous disclosures are also required for goodwill and the associated annual impairment review. When a CGU includes goodwill or an intangible asset assigned an indefinite useful life, the company is required to disclose information about the estimates used to measure the recoverable amount of the unit. Additional disclosure requirements apply when it is reasonably possible that a change in a key assumption would result in an impairment loss.

First-Time Adopters For most European exchange-listed companies, the financial statements for the year 2005 were the first IFRS statements. The rules for the transition from the companies’ respective local GAAP to IFRS, that is, for the “first-time adoption of IFRS”, are provided in IFRS 1. Generally, companies must present their first IFRS statements as if they had always used IFRS. However, there are exceptions to this rule. First-time IFRS adopters must apply IFRS 3 to transactions after the date of transition but may select whether or not to restate prior acquisitions.23 The option is allowed for all acquisitions from the date of the earliest selected restatement. Selective restatement is not allowed. First-time adopters must apply the same accounting standards for all periods covered by the initial financial statements. Therefore, 31 December 2005 first-time adopters had to apply the new IFRS standards from 1 January 2004.

Historically, accounting standards throughout Europe included different treatments for accounting for business combinations and goodwill. Most importantly, some countries allowed goodwill to be offset against equity without having any effect on profit and loss (e.g. Germany, Switzerland, Luxembourg). Other countries required the capitalisation and amortisation of goodwill. The majority of the companies included in our study are 2005 first-time adopters and most choose not to restate prior business combinations. Thus, the accounting for their previous acquisitions remains unchanged and serves as the basis for the opening IFRS balances. For example, a company with an acquisitive history that chose to offset goodwill against equity prior to adopting IFRS has an initial IFRS balance of zero for goodwill. If the same company alternatively resided in another European country that required capitalisation of goodwill, the balance sheet would likely contain a considerable goodwill position. Obviously, this complicates comparisons of goodwill-related key figures across European companies.

Opposition to ED 3 and IFRS 3 While debating the Exposure Draft preceding IFRS 3 from 2002 through 2004, the IASB encountered divergent views that included substantial opposition to the requirements of the forthcoming standard and the IASB’s rigorous and complex approach to impairment testing. Some argued that the Exposure Draft proposed fundamental changes to standards that had only recently been revised. National standard setters all over Europe criticised the proposed changes. The European Federation of Accountants (FEE) and the European Financial Reporting Advisory Group (EFRAG) were sceptical of the proposals.

One of the most frequent criticisms concerns the increased use of fair value as fair value requires management’s judgement when there is no active market. Opponents of IFRS 3 further argue that existing standards do not provide clear, detailed guidance on how fair values are measured or estimated. Even the IASB concedes that the existing guidance on measuring fair value is dispersed throughout various IFRS, thereby, adding unnecessary

23 For details, see IFRS 1, Appendix B.

While debating the Exposure Draft preceding IFRS 3, the IASB encountered divergent views that included substantial opposition to the requirements of the forthcoming standard and the IASB’s rigorous and complex approach to impairment testing.



21

complexity and that the existing guidance is not always consistent. When considering requests for additional implementation guidance, the IASB and other standard setters are however faced with the tradeoffs associated with providing the requested detailed guidance and being too prescriptive or rules-based (as opposed to principles based).

Fair Value Measurement and SFAS 157 Both the IASB and the Financial Accounting Standards Board (FASB) are actively addressing fair value measurements. In September 2006, the FASB published SFAS 157, “Fair Value Measurement”. The U.S. standard defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurement. The definition of fair value utilises the exchange price notion and emphasises that fair value is a market-based measurement, not an entity-based measurement.

Given that the IASB and FASB are committed to convergence of standards and the development of a common conceptual framework, the IASB is using SFAS 157 as a starting point for its own project on Fair Value Measurement. The IASB has recently issued a discussion paper that outlines the Board’s preliminary views on SFAS 157 and highlights differences between the U.S. standard and existing fair value guidance in IFRSs.24 Comments received on the preliminary views document will be considered in conjunction with the development of an IASB Exposure Draft on fair value measurement. The ultimate goal of the IASB project is to establish a single source of guidance for all fair value measurements required by IFRSs and to clarify the definition of fair value and related guidance in order to more clearly communicate the measurement objective.

ED IFRS 3 and the Full Goodwill Method As the IASB continues to move forward with its overall project on business combinations, the controversy continues. In “Phase 2” of their business combinations project, the IASB and FASB are jointly addressing those aspects of business combinations not reviewed in the development of IFRS 3 (“Phase 1”), implementation issues arising from the application of IFRS 3 and how to eliminate differences in the application of the purchase method between IFRS and U.S. GAAP.

As a first result of their deliberations in Phase 2, the IASB and the FASB in June 2005 issued an Exposure Draft to amend IFRS 3 and the respective U.S. standard. A key element of the proposal is the so-called full goodwill method. Under this form of the purchase method, goodwill represents the excess of the fair value of the acquiree, as a whole, over the net amount of the recognised identifiable assets acquired and liabilities assumed. The requirement holds even when the acquirer owns less than 100% of the equity interests in the acquiree at the acquisition date and minority interests in the acquiree exist at the acquisition date. The full goodwill method is highly controversial because of the increased use of fair value measurements. The majority of IASB board members believe the full goodwill method is relevant because it is consistent with the control and completeness concepts underlying the preparation of consolidated financial statements. However, five IASB members disagree and set out alternative views in an Appendix to ED IFRS 3.

Given the level of controversy associated with the proposals set forth in ED IFRS 3, the IASB and FASB are presently debating whether the current proposals may be progressed towards a final joint standard without re-exposure or whether significant changes to the proposals should be contemplated.

24 See IASB (2006), Fair Value Measurements, Discussion Paper, November 2006.

The goal of a current IASB project is to establish a single source of guidance for all fair value measurements required by IFRSs and to clarify the definition of fair value and related guidance.


M&A-Related Disclosures – Empirical Study

22

D M&A-Related Disclosures – Empirical Study

1 Methodology and Sample

Methodology The goal of our empirical study is to provide an overview of the level of M&A activity by leading European listed companies and, more importantly, to assess comprehensively how these companies apply IFRS merger accounting in their 2005 financial statements. To achieve this goal, we thoroughly reviewed all required and recommended disclosures set forth in IFRS 3 and IAS 36 for business combinations, goodwill and other intangibles and impairment testing, for a total sample of 357 major European companies (see below for a detailed description on the sample selection process). More specifically, our review focused on inter alia the

● number, size and materiality of the acquisitions undertaken in 2005; ● costs of, and the purchase price allocation for, these acquisitions; ● goodwill (or badwill) resulting from the 2005 acquisitions; ● total goodwill positions appearing on the companies’ consolidated balance sheets,

accruing also from acquisitions in previous periods; ● relative importance of other intangible assets, especially those assigned indefinite useful

lives; ● details of the goodwill impairment tests conducted; ● number and amount of impairment charges related to tangible and intangible assets in

2005. For each area studied, we analysed and evaluated the types of information disclosed and the format utilised by the companies to provide the information. In many areas, we find that the information provided under the new IFRS disclosures has indeed lead to increased transparency. However, we also identify and discuss some areas where more effort is needed to embrace the spirit of the new disclosure requirements and met the needs of financial statement users.

Sample Selection Our sample includes companies listed in the premier segments of the 17 most important European stock exchanges. We began by collecting the 2005/2006 annual reports of these companies for the year ended 31 December 2005 (see Table 2). Adding up the companies included on each of the individual indices yields a total number of 483 companies. However, 22 of the companies are cross-listed (listed on at least two of the 17 stock exchanges).25 Thus, our total potential sample is made up of 461 companies. We next eliminate 22 companies using U.S. GAAP and thus not yet applying IFRS, 24 companies with a year-end not falling between 31 December 2005 and 31 March 2006, 20 companies not providing an English language annual report that includes consolidated IFRS group accounts and five additional companies that for various reasons do not provide a 2005 IFRS annual report. After reviewing the annual reports of the remaining 390 companies, we find that 33 neither report any acquisitions for their financial year 2005 nor do they have any goodwill from previous transactions on their consolidated balance sheets. Hence, these companies are also eliminated, leaving a final sample consisting of

25 Where possible, we include double listed companies in the countries where they are domiciled and eliminate them from other country sub-samples. In a few cases, however, companies are listed on exchanges outside their home countries without being included in the stock market index of their home country. For instance, one of the companies that makes up the FTSE 100 index is legally domiciled in Switzerland, and it is not included in the Swiss SMI index. Such companies voluntarily submit themselves under the regulatory framework of the country of listing. Therefore, we include these companies in the primary country where they are listed and included in the stock market index (in our example, the company is included in the U.K. country sub-sample).

Our study provides an overview of the level of M&A activity by leading European listed companies and, more importantly, assesses comprehensively how these companies apply IFRS merger accounting in their 2005 financial statements.



23

357 companies. Table 2 illustrates how the companies are distributed over the 17 countries.

Country Index Companies comprising index (31 Dec. 2005)

Companies satisfying sample criteria

Austria ATX 20 16 Belgium BEL 20 19 16

Czech Republic PX Index 14 6 Denmark OMXC 20 20 14

Finland OMXH 25 24 21 France CAC 40 40 34

Germany DAX 30 30 21 Hungary BUX 12 6

Ireland ISEQ 20 20 14 Italy S&P/MIB 40 33

Luxembourg LuxX 11 4 Netherlands AEX 23 18

Poland WIG 20 20 13 Spain IBEX 35 35 28

Sweden OMXS 30 29 20 Switzerland SMI 26 18

United Kingdom FTSE 100 100 75 483 357

Tab. 2 Sample selection

Sample Characteristics Figure 5 provides a breakdown of sample companies by industry. The most heavily represented industries are industrial products (61 companies), retail & consumer goods (53) and banks (45). Other industry groupings that include at least 20 companies are utilities (38), entertainment & media (29), telecommunications (26), insurance (22) and services (20). A total of 81 companies are in one of the financial services industries (i.e., banks, insurance or other financial services).

17

18

20

22

26

29

38

45

53

61

14

14

0 10 20 30 40 50 60 70

Chemicals

Other Financial Services

Pharmaceuticals

Basic Materials

Services

Insurance

Telecommunications


Utilities

Banks

Retail & Consumer Goods

Industrial Products

Fig. 5 Number of sample companies by industry

Figures 6 through 8 report size indicators (total revenue and total assets) for the sample companies by country and by industry. Figures 6 and 7 report the average revenue by country and industry, respectively. By far, companies with the largest revenue are headquartered in Germany (€ 29.4 billion), France (€ 26.0 billion) and the Netherlands (€ 25.9 billion). The countries with the smallest companies in our sample, in terms of average revenue, are the Central Eastern European countries, Poland, the Czech



24

Republic and Hungary, with average revenue of € 2.4 billion each. Austrian and Irish companies are also noticeably smaller than the companies from other Western European countries with average revenue of € 3.1 billion each.

29,4

36.5

26,0

26.5

25,8

79.9

15,6

80.6

11,9

59.5

11,4

90.2

9,88

0.9

8,89

2.6

7,90

9.4

5,85

8.4

5,46

4.9

5,03

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3,07

1.2

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2,41

4.8

2,40

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0.4

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

German

y

France

Netherl

ands

United

King

dom Ita

ly

Switzerl

and

Luxe

mbourg

Spain

Sweden

Finlan

d

Belgium

Denmark

Irelan

d

Austria

Poland

Czech

Rep

ublic

Hunga

ry

In m

illio

n €

Fig. 6 Average revenue per company by country in 2005

For companies in the non-financial industries, revenue, on average, is € 13.0 billion with a substantial variation (standard deviation € 25.2 billion). As illustrated in Figure 7, from an industry perspective, companies in the utilities industry, on average, have by far the largest revenues. The average of € 29.6 billion is almost double that of the telecommunications industry (€ 15.0 billion) and greatly exceeds that of all the other industries represented in the sample. The industry with the smallest revenue is entertainment & media, with an average of only € 5.1 billion.26

For the overall sample, total assets, on average, is € 78.3 billion with a very large range (standard deviation € 211.2 billion). Average total assets are reported by industry in Figure 8. The largest companies in terms of total assets are, on average, the financial services industries (banks € 358.2 billion; insurance € 241.7 billion and other financial services € 111.3 billion) which dwarf companies from other sectors. The largest non-financial companies are in the utilities (€ 37.4 billion) and telecommunications (€ 32.2 billion) sector. The smallest are in the entertainment & media industry (€ 6.9 billion).

26 The financial services industries (banks, insurance and other financial services) are not included in the computation of revenue statistics.

For the sample, total assets, on average, is € 78.3 billion with a very large range.



25

29,6

47.7

0

15,0

44.3

0

11,4

34.7

0

11,1

29.9

0

10,6

10.3

0

9,94

1.20

9,04

4.70

8,26

6.80

5,12

2.50

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Utilities

Teleco

mmunica

tions

Retail &

Con

sumer

Goods

Indus

trial P

roduc

ts

Chemica

ls

Pharm

aceu

ticals

Service

s

Basic

Materia

ls

Enterta

inmen

t & M

edia

In m

illio

n €

Fig. 7 Average revenue per company by industry in 2005

358,

200.

80

241,

689.

60

111,

348.

10

37,4

22.9

0

32,2

11.6

0

17,2

88.2

0

16,3

28.6

0

15,1

98.5

0

11,2

78.1

0

11,2

17.6

0

10,8

06.8

0

6,89

6.30

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

Banks

Insura

nce

Other F

inanc

ial S

ervice

s

Utilitie

s

Teleco

mmunica

tions

Service

s

Pharm

aceu

ticals

Indus

trial P

roduc

ts

Basic

Materia

ls

Chemica

ls

Retail &

Con

sumer

Goods

Enterta

inmen

t & M

edia

In m

illio

n €

Fig. 8 Average total assets per company by industry in 2005

For the total sample, net income, on average, is € 1.2 billion. Again, the variation is great (standard deviation € 2.9 billion). As illustrated in Figure 9, on average, companies based in The Netherlands (€ 2.4 billion) and France (€ 2.2 billion) report the highest net income exceeding € 2 billion. Companies headquartered in Switzerland (€ 1.8 billion), Germany (€ 1.6 billion), the U.K. (€ 1.4 billion), Luxembourg (€ 1.3 billion), Italy (€ 1.2 billion) and Spain (€ 1.2 billion) reported net income, on average, exceeding € 1.0 billion.

Breaking the sample down along industry lines, as shown in Figure 10, companies in the utilities industry (€ 2.9 billion) and the banking industry (€ 2.3 billion) presented the highest net income. In both sectors, companies report net income, on average, in excess of € 2 billion. On average, companies in the insurance (€ 1.9 billion), pharmaceuticals (€ 1.6 billion) and other financial services (€ 1.3 billion) industries reported net income greater than € 1.0 billion.

For the sample, net income, on average, is € 1.2 billion, and, the variation is great.



26

2,36

4.60

2,17

3.70

1,80

8.00

1,58

3.50

1,40

4.00

1,33

2.00

1,18

5.70

1,16

1.80

803.

8

743.

3

738.

6

661.

4

412.

4

409.

4

348.

8

307.

1

302

0

500

1,000

1,500

2,000

2,500

Netherl

ands

France

Switzerl

and

German

y

United

King

dom

Luxe

mbourg Ita

lySpa

in

Czech

Rep

ublic

Sweden

Belgium

Denmark

Irelan

d

Finlan

d

Austria

Hunga

ry

Poland

In m

illio

n €

Fig. 9 Average net income per company by country in 2005

2,93

2.60

2,30

7.40

1,89

4.80

1,59

3.60

1,30

3.90

919.

2

708.

6

694.

8

585.

8

531.

8

419.

2

351.

3

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Utilities

Banks

Insura

nce

Pharm

aceu

ticals

Other F

inanc

ial S

ervice

s

Basic

Materia

ls

Chemica

ls

Retail &

Con

sumer

Goods

Service

s

Indus

trial P

roduc

ts

Enterta

inmen

t & M

edia

Teleco

mmunica

tions

In m

illio

n €

Fig. 10 Average net income per company by industry in 2005

2 Acquisitions in 2005 In this first section presenting the results of our empirical analysis, we provide an overview of the acquisitions undertaken by the sample companies in 2005 and analyse the disclosures associated with these transactions. As explained in the preceding section on the methodology of the study, our sample includes companies with financial years ending between 31 December 2005 and 31 March 2006. To simplify our discussion, in the following, we refer to all statements as 2005.

Of the 357 companies comprising our sample, 241 (68%) reported acquisitions during 2005. Of the remaining companies, 116 reported no acquisitions in 2005 but present goodwill resulting from acquisitions before 2005 in their consolidated balance sheets.

According to IFRS 3, (para. 67) companies are required to disclose detailed information on business combinations that occur during the reporting period. For individually immaterial transactions, companies are only required to report in aggregate.27 Individual transactions are reported on by 167 companies (47%); of these, 38 also reported in aggregate on

27 See IFRS 3 (para. 68).

Approximately two-thirds of the sample companies reported acquisitions during 2005.



27

“other”, usually minor transactions. Furthermore, 74 companies only provided aggregate disclosures for their acquisitions. By reporting some or all of their 2005 transactions in aggregate, companies imply that none of these were individually material.

Companies not reporting any acquisitions;

116; 32%

Companies that report individual

acquisitions; 167; 47%

Companies that report

acquisitions only in aggregate;

74; 21%

Fig. 11 Companies reporting acquisitions for financial year 2005

Based on all the information provided in the notes to the annual reports, the 241 companies reporting acquisitions completed at least 788 transactions in 2005.28 As shown in Table 3, 74 companies undertook only one acquisition, 59 companies reported on two transactions. Numerous others undertook three, four or more acquisitions; eight recorded more than 10 acquisitions. One company, a British service company, reported no less than 40 acquisitions in 2005. For the total sample, the average number of acquisitions per company is 2.21, or 3.27 for the sub-sample of 241 companies reporting acquisitions in 2005.

Number of acquisitions reported in 2005

0 1 2 3 4 5 6 7 8 9 10 11-20

> 20

Number of companies

116 74 59 41 18 14 12 7 3 0 5 7 1

Tab. 3 Number of acquisitions reported per company in 2005

As expected, the number of acquisitions varies greatly by industry. Figure 12 shows that – based on our analysis of European blue-chip companies – the services industry had by far the highest takeover activity in 2005, with 119 acquisitions and an average of 5.95 acquisitions per company.29 The industrial products sector also displays above-average takeover activity with the 61 companies undertaking 170 acquisitions in 2005. The ratio of acquisitions per company in the industrial products industry is 2.79. Interestingly, the incidence of acquisitions is relatively low in the pharmaceuticals and utilities industries. In both industries, extremely large transactions have taken place in recent years. However, while individual transactions can be very large, our data for the year 2005 suggests that companies in the pharmaceuticals and utilities industries may engage in relatively few transactions in a given year.

28 In some cases, the number of acquisitions reported upon in aggregate is not disclosed. Several companies only declare there had been “other” transactions. In these cases, we assume at least two such transactions occurred during the year. In cases where companies describe in detail one or two (or n) transactions and communicate there had been “other” (minor) transactions as well, we assume there had been two “other” transactions. 29 We compute the ratio of the number of acquisitions to the total number of companies per industry. If we eliminate the extreme case (“outlier”) of a British service company with 40 acquisitions in 2005, the ratio for the service industry drops to 3.95, which is still by far the highest ratio for all industries.

In 2005, 241 of the sample companies completed at least 788 M&A transactions.



28

From a country perspective (see Figure 13), we find the highest ratio of acquisitions per company for companies based in Austria (3.19). We also find above-average ratios for Denmark (3.14) and Finland (2.95). The three Central Eastern European countries (Poland, Czech Republic and Hungary) have the least active markets for M&A. As explained below, these findings are consistent with the generally low levels of goodwill found in the annual reports of companies in these countries. Although the Central Eastern European countries underwent far-reaching transformation processes since the demise of their socialist systems, they have not yet developed significant numbers of large companies with the financial and managerial resources that are prerequisites for implementing acquisition strategies. Moreover, some sectors of the capital markets in these countries have yet to be fully liberalised.

1.62

1.68

1.79

1.85

2.14

2.21

2.25

2.28

2.79

5.95

1.32

0.71

0 1 2 3 4 5 6 7

Pharmaceuticals

Utilities

Banks

Insurance


Telecommunications

Chemicals



Basic Materials

Industrial Products

Services

Fig. 12 Frequency of acquisitions (number of acquisitions per company) per industry in 2005

1.46

1.55

1.71

1.75

1.83

1.9

2.04

2.31

2.32

2.36

2.4

2.72

2.95

3.14

3.19

1.17

0.5

0 0.5 1 1.5 2 2.5 3 3.5

Hungary

Czech Republic

Poland

Italy

Ireland

Luxembourg

Switzerland

Germany

Spain

Belgium

France

United Kingdom

Sweden

Netherlands

Finland

Denmark

Austria

Fig. 13 Frequency of acquisitions per country in 2005

Cost and Materiality of Acquisitions To assess the size of the M&A transactions undertaken in 2005, we collected information on the cost of the acquisitions. According to IFRS 3, (para. 67 (d)), companies are required to disclose the cost of acquisitions for all business combinations. For business combinations that are individually immaterial, the cost only has to be disclosed in aggregate. For the 299 individually reported transactions, the cost is disclosed in the vast

From a country perspective, the highest ratio of acquisitions per company is for companies based in Austria. We also find above-average ratios for Denmark and Finland.



29

majority of cases (284). Similarly, most (104 of 112) companies that report on aggregate acquisitions disclose the (aggregate) cost.

Cost Number of transactions < 1 27

1 to 4.9 27 5 to 9.9 16

10 to 19.9 16 20 to 49.9 35 50 to 99.9 41

100 to 249.9 44 250 to 499.9 32 500 to 999.9 16

1,000 to 4,999.9 25 5,000 to 9,999.9 3

≥ 10,000 2 cost not disclosed 15

∑ 299

Tab. 4 Cost of acquisitions in 2005 (individually reported transactions only, in million €)

In Table 4, we show the distribution of the cost of the individually reported transactions. There is great variance in the costs of the acquisitions. In 27 of the individually reported cases, the cost is below € 1.0 million, while 30 transactions cost at least € 1.0 billion each. The average acquisition cost for all individually reported transactions is € 0.5 billion, with a standard deviation of € 1.6 billion.

For aggregate disclosures, we estimate the cost of the individual acquisitions by dividing the aggregate cost by the estimated number of transactions. Based on all the information (i.e., the cost of the individually reported transactions and the estimated cost of those acquisitions that are reported only in aggregate) the average acquisition cost for 2005 transactions of the leading European companies is € 0.2 billion, and the standard deviation is € 1.1 billion.

To assess the materiality of the transactions for the acquiring companies, we compute the ratio of the cost of the acquisitions to the acquirers’ total assets.30 We again differentiate between the individually reported acquisitions and the acquisitions reported only in aggregate. Figure 14 reveals that the majority of transactions reported individually are very small in relation to the size of the acquiring companies. In 93 of the 299 cases, the cost of the business acquisition is less than 0.1% of the companies’ total assets, and there are 178 transactions where the cost is less than 1% of the companies’ total assets. Based on this ratio, these acquisitions could be considered immaterial. There may of course be other reasons why some of these transactions are of strategic importance to the companies and the information about them, therefore, is viewed as being relevant to financial statement users. However, it is nonetheless somewhat surprising that so many companies chose to report in detail about what appears to be immaterial acquisitions.

30 We compute the ratio between the cost of the acquisition and total assets in the companies’ 2005 financial statements, that is, in the statements including the acquired companies’ assets and liabilities and the goodwill resulting from the transaction. This ratio underestimates the materiality of the transaction for the acquiring companies as it does not reflect the transaction values in relation to the pre-acquisition volume of total assets.

The majority of M&A transactions reported individually are very small in relation to the size of the acquiring companies. In 93 of the 299 cases, the cost is less than 0.1% of the companies’ total assets, and there are 178 transactions where the cost is less than 1% of the companies’ total assets.



30

3

17

21

22

41

31

54

93

2

15

0 10 20 30 40 50 60 70 80 90 100

Information not disclosed

30%

20 to 29.9%

10 to 19.9%

5 to 9.9%

2.5 to 4.9%

1 to 2.49%

0.5 to 0.99%

0.1 to 0.49%

< 0.1%

Fig. 14 Materiality of acquisitions: Costs of individually reported transactions to companies’ total assets in 2005

Some transactions, on the other hand, are large in relation to the total assets of the company. In 43 of the 299 individually reported transactions the cost of the business combination exceeds 5% of the companies’ total assets. The ratio is between 5 and 10% in 21 cases, and in 17 cases the ratio is between 10 and 20%. In five cases the ratio of cost to total assets actually exceeds 20%. The highest ratio of acquisition cost to total assets is 40% for a Swedish entertainment & media company.

For the acquisitions reported in aggregate, in several cases, we can only estimate the number of acquisitions. Furthermore, we cannot determine how the reported aggregate cost is distributed over the individual transactions. Therefore, we consider aggregate cost in relation to total assets. As shown in Figure 15, in many cases the acquisitions reported in aggregate can indeed be considered immaterial. In 17 cases, the total aggregate cost is less than 0.1% of the companies’ total assets. For a total of 54 cases the ratio is less than 1%. However, it is noteworthy that in some cases the total cost of acquisitions reported only in aggregate are very large. In 14 cases the total cost is larger than 5% of total assets, and in four cases the ratio even exceeds 10%. One may question whether the aggregate disclosure format is appropriate in such cases.

10

12

24

13

24

17

4

8

0 5 10 15 20 25 30


10%

5 to 9.9%

2.5 to 4.9%

1 to 2.49%

0.5 to 0.99%

0.1 to 0.49%

< 0.1%

Fig. 15 Materiality of acquisitions: Costs of transactions reported in aggregate to companies’ total assets in 2005

In some cases, the total cost of acquisitions reported only in aggregate are very large (i.e., exceeding 5% or even 10% of total assets).

≥

≥



31

Mode of Payment for Acquisitions – Cash vs. Paper The acquiring company can obtain the equity instruments of the acquiree in exchange for cash, can compensate the former owners with debt instruments (deferred payment), or issue equity instruments. Combinations of cash and paper can also be used.

The mode of payment is very important to the transaction partners and to investors in the capital markets. First, the form of payment can have tax consequences for both buyer and seller. Second, from the viewpoint of the seller, compensation in cash is the most direct and least risky option. For the acquirer, payment in cash has the disadvantage of drawing on the company’s liquidity. In the case of larger transactions, cash payments may need to be financed through additional debt, leading to a higher debt-equity ratio and, possibly, to a deterioration of the company’s credit rating. Cash deals may thus have a negative impact on the value of a company’s currently outstanding debt. If, on the other hand, the acquisition is financed by an exchange of equity, the liquidity of the acquiring company is not directly affected. However, the ownership rights of current shareholders are diluted; they now have to share control of the company with the former owners of the acquiree. Third, the use of a company's own shares as “takeover currency” may be interpreted by the capital market as a signal that the acquiring company’s management believes their own shares may be overvalued. Moreover, with an equity deal, the former owners of the target company participate in the combined entity. Hence, they share the risks of the acquisition. In this sense, the use of equity as a means of exchange may also signal that the acquiring company’s management is not fully convinced of the success of the transaction. Consistent with these theoretical considerations, empirical research studies indicate that companies undertaking cash acquisitions are, on average, more successful in the stock market than companies that issue equity to pay for acquisitions.31

Given the relevance of the mode or payments for investors and other users of financial statements, IFRS 3 (para. 67 (d)), requires companies to provide a description of the components of the cost of the business combination, including any costs directly attributable to the combination (e.g., fees paid to accountants, legal advisers, valuers and other consultants to effect the combination).32 Specific information has to be provided if equity instruments are issued as part of the cost; in particular, the company has to disclose the number of the equity instruments issued, the fair value of those instruments and the basis for determining fair value.33

Our analysis of the companies’ footnotes reveals that the required description of the components of the cost of business combinations is disclosed for only about two thirds of the transactions. This holds true both for the individually reported transactions (description provided for 199 of 299 cases, or 66.6%) as well as for transactions reported in aggregate (description provided for 76 of 112 cases, or 67.9%). In some of the cases where the information is not explicitly presented, one can determine from the cash flow statement whether the takeover has been financed by cash. Furthermore, one can utilise the statement of changes in shareholders’ equity to determine whether shares have been issued during the period in question. Thus, one can often exclude the possibility of share-financed acquisitions. However, it would be easier and transparency would be enhanced if all companies provided the required disclosure in the footnotes and informed financial statement users explicitly on the components of the cost of their business combinations.

In 20 cases, companies report that equity was issued as part of the cost of their 2005 business combinations. As expected, most equity-financed transactions are for individually reported transactions. Seventeen of the 299 transactions were, partly or wholly, financed

31 See Sudarsanam, S. (2003), Creating Value from Mergers and Acquisitions: The Challenges, Chapter 16, for a detailed discussion of the advantages and disadvantages of alternative modes of payment in acquisitions. 32 See IFRS 3 (para. 29), for further explanations on the “costs directly attributable to the combination”. 33 See IFRS 3 (para. 67(d) (i) and (ii)).

The required description of the components of the cost of business combinations is disclosed for only about two thirds of the M&A transactions.



32

through the issuance of equity (5.69%). In three cases, equity was issued to finance transactions that companies disclosed only in aggregate. While the fair value of the equity instruments issued is disclosed in all but one of the 20 cases, “the basis for determining that fair value” (IFRS 3.67(d)(ii)) is made explicit only in eleven of the 20 cases.

Purchase Price Allocation – Number of Classes of Assets and Liabilities According to IFRS 3 (para. 16), applying the purchase method involves three steps: identifying an acquirer, measuring the cost of the business combination and “allocating, at the acquisition date, the cost of the business combination to the assets acquired and liabilities and contingent liabilities assumed”. The first and second steps are relatively straightforward in most cases. The third step, the so-called purchase price allocation (PPA), however is not. This step involves identifying, and valuing at fair value, all acquired assets, assumed liabilities and contingent liabilities, including assets and (contingent) liabilities that may not have been recognised by the acquiree before the business combination. As explained previously in section C, this can be a very demanding and onerous process.

Companies are required to provide extensive information about the PPA. According to IFRS 3 (para. 67 (f)), companies are required to disclose

“the amounts recognised at the acquisition date for each class of the acquiree’s assets, liabilities and contingent liabilities, and, unless disclosure would be impracticable, the carrying amounts of each of those classes, determined in accordance with IFRSs, immediately before the combination. If such disclosure would be impracticable, that fact shall be disclosed, together with an explanation of why this is the case”.34

This information is considered necessary by the IASB “to provide the users of an acquirer’s financial statements with information that enables them to evaluate the nature and financial effect of business combinations”.35

Our findings indicate that reporting on PPA, even though deemed important by the IASB, is rather problematic for preparers of financial statements. For about a quarter of the disclosures on individual or aggregate acquisitions36, no information is given about the classes of acquired assets, liabilities and contingent liabilities. In ten cases (9.1% of the cases where PPA disclosure is missing), the companies indicate the accounting for the business combinations was determined only provisionally, for instance, because the takeover had taken place close to the reporting date.37 In only three of the other cases (2.7% of the cases where PPA disclosure is missing), the companies present an alternative explanation of why the disclosure was impracticable.

PPA disclosure appears to be problematic in the insurance and banking industry. In the insurance industry, PPA disclosures are only provided in 10 of the 27 reports about individual or aggregate acquisitions (37.1%). In the banking sector, disclosures of PPA are included in only 27 of the 59 reports (45.8%).

34 The term “impracticable” is defined in IAS 8 (para. 5): “Applying a requirement is impracticable when the entity cannot apply it after making every reasonable effort to do so”. 35 IFRS 3 (BC 170 and BC 174). 36 With regard to PPA, we do not find a marked difference between disclosures about individually reported transactions and acquisitions that are reported in aggregate. 37 If the initial accounting for the business combination can only be determined provisionally at the reporting date, according to IFRS 3 (para. 62), companies can complete the recognition and valuation of assets acquired and liabilities assumed within a time span of twelve months from the date of the acquisition; the carrying value of goodwill (badwill) is adjusted accordingly. A total of 71 companies explain that the accounting for at least one of their acquisitions was determined only provisionally at the balance sheet dates (50 individually reported transactions, 21 sets of aggregate transactions). Of these, 61 companies provide the required disclosures on the (provisionally determined) PPA; ten did not provide the required disclosures.

Our findings indicate that reporting on PPA, even though deemed important by the IASB, is rather problematic for preparers of financial statements.



33

Many companies present the required information on assets acquired and liabilities assumed in tabular form. In the first column, they list the classes of assets acquired and liabilities assumed and the resulting net asset (net liability) position and present in the subsequent columns the carrying amounts of these classes before the combination, the fair-value adjustments and the fair values recognised in the consolidated statements.

As depicted in Figure 16, a majority of the companies provide relatively transparent disclosures regarding PPA and distinguish between five and nine classes of assets, liabilities and contingent liabilities. In 68 cases, companies allocate purchase price between ten and 15 classes, and in eight cases the number of classes reported is between 16 and 20. One company goes as far as to allocate assets and liabilities to 26 classes.

In certain other cases, even when information on PPA is provided, the level of detail is somewhat limited. Twelve companies provide information on only one class of asset, usually by explaining that property, plant and equipment, or intangibles, or another specific class of assets acquired, amounted to a specific amount of Euro, or to a specific percentage of the total cost of the acquisition. Eight companies provide details regarding only two classes of assets. Most of the companies in this latter group provide a break down of total assets acquired into tangible and intangible.

Purchase Price Allocation – Intangible Assets Figure 17 shows the number of classes of intangible assets for all cases where the information is provided in the required PPA disclosures. In a large majority of the cases (158), companies provide information for only one class of intangibles. In 34 cases, companies distinguish two classes of intangibles. In 26 individual or aggregate acquisition disclosures, companies are more specific and distinguish three, four or, in one case, five classes of intangibles. The 26 cases where details are provided for three or more classes of intangibles are related to 22 companies. These highly disaggregated disclosures appear most frequently in the entertainment & media (five companies); telecommunications (five companies) and banking industries (three companies), respectively.

1811

34 39 3428

41

24

44

81

109

812

0

20

40

60

80

100

120

1 2 3 4 5 6 7 8 9 10

11 to

15

16 to

20 > 20

Inform

ation

not d

isclos

ed

Fig. 16 Purchase price allocation: Number of classes of assets acquired, and liabilities and contingent liabilities assumed in 2005

A majority of the companies provide relatively transparent disclosures regarding PPA. However, in certain other cases, even when information on PPA is provided, the level of detail is somewhat limited.



34

196 1

34

158

0

20

40

60

80

100

120

140

160

180

1 2 3 4 5

Fig. 17 Purchase price allocation: Number of classes of intangible assets acquired in 2005

Purchase Price Allocation – Contingent Liabilities As explained in section C, IFRS 3 requires that contingent liabilities assumed by a company in the context of an acquisition be recognised in the acquirer’s consolidated balance sheet at fair value if they can be measured reliably.

Our analysis reveals that contingent liabilities are recognised rarely. Of the 299 individual acquisitions and 112 aggregated sets of acquisitions reported by our sample, only in four cases (< 1%) do companies report contingent liabilities. In two of these cases, the contingent liabilities are subsumed in aggregate positions (contingent liabilities and other financial obligations, contingent liabilities and provisions). Only two companies actually report contingent liabilities as a separate class in their PPA disclosures. In both cases, the values of the contingent liabilities assumed amount to less than 1% of the costs of the business combination.

To summarise, in contrast to the intensive debate about the recognition of contingent liabilities in the literature38, our analysis provides evidence that contingent liabilities are basically irrelevant for the allocation of the cost of business combinations in practice. We are not able to discern whether this is because there are extremely limited material contingent liabilities in reality or whether companies refrain from recognising, or reporting on them, for other reasons. The recognition of contingent liabilities based on IFRS 3 (paras. 37 and 47) always requires a certain degree of professional judgement. For instance, when such liablilties exist, management determines whether or not their fair values can be measured reliably. The need for judgement gives management some scope to decide whether or not to recognise a contingent liability. Another reason might be a decision taken that identified contingent liabilities are regarded as immaterial.

Goodwill (and Badwill) Resulting from 2005 Acquisitions As emphasised previously, one of the most important recent changes in merger accounting according to IFRS (and U.S. GAAP) is that goodwill can no longer be amortised. Instead, goodwill must be tested for impairment at least annually. Impairment of goodwill may lead to sporadic, and potentially large, charges to earnings.

38 See, for instance, Hommel, M. / Benkel, M. / Wich, S. (2004), IFRS 3 Business Combinations: Neue Unwägbarkeiten im Jahresabschluss, in: Betriebs-Berater, Vol. 59, Nr. 23, pp. 1271-1272; Alfredson, K. et al. (2005), Applying International Accounting Standards, pp. 394-395; also see IFRS 3 (BC 107 to BC 117).

Our analysis provides evidence that contingent liabilities are basically irrelevant for the allocation of the cost of business combinations in practice. We are not able to discern whether this is because there are extremely limited material contingent liabilities in reality or whether companies refrain from recognising, or reporting on them, for other reasons.



35

Goodwill results if the cost of the business combination is higher than the sum of the fair values of the assets acquired minus the sum of the fair values of the liabilities and contingent liabilities assumed in the course of a business combination. Given that IFRS requires that the intangible assets acquired generally have to be recognised in the consolidated financial statements, goodwill results mainly from going-concern elements as well as from growth and synergy expectations reflected in the price of the acquisition. Obviously, an alternative reason for an acquisition price that exceeds the net fair value of the target’s assets is that the management of the acquirer overpaid. The latter scenario will eventually result in an impairment of goodwill.

If the net fair value of the target exceeds the purchase price, negative goodwill (badwill) results. In principle, badwill can be due to a “lucky buy”; that is, the acquiring company paid less than the actual economic value of the acquiree. However, for obvious reasons in a normal business environment such an outcome is rather unlikely. Second, the difference between the cost of the acquisition and the net fair value may represent compensation for expected future losses which are not yet recognised on the balance sheet (i.e., in the form of provisions). Third, the difference can stem from IFRS requirements that prohibit certain assets or liabilities from being measured at their true fair value, thus leading to an overvaluation of these assets or an understatement of liabilities. For instance, according to IFRS 3 and IAS 12, the amounts assigned to tax assets and tax liabilities (deferred taxes) are undiscounted.39 Irrespective of the reason, the so-called “excess of the acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over cost” is recognised immediately as a gain in the profit and loss statement (IFRS 3, para. 56).

Tables 5 and 6 provide details about goodwill resulting from acquisitions undertaken in 2005 by our sample companies. In the first table, we summarise the information for individually reported acquisitions. The second table relates to acquisitions reported in aggregate.

< 0

(Bad

will

)

0 0.01

to 0

.9

1 to

4.9

5 to

9.9

10 to

24.

9

25 to

49.

9

50 to

99.

9

100

to 2

49.9

250

to 4

99.9

500

to 9

99.9

1000

to

4999

.9

≥ 50

00

Info

rmat

ion

not

disc

lose

d

14 36 12 27 12 24 31 28 38 21 9 11 3 33

Tab. 5 Goodwill resulting from 2005 acquisitions (individually reported transactions, in million €)

As illustrated in Table 5, badwill was recognised for 14 individually reported transactions. It is interesting that three of these transactions were undertaken by the same company, a Polish utilities company. Three other transactions resulting in badwill were also undertaken by Polish companies. For the remaining transactions resulting in the recognition of badwill, for two cases the acquirers are located in the Czech Republic, and six relate to companies from various other countries.

In 36 cases neither goodwill nor badwill was recognised, that is, the fair value of the recognised net assets equalled the cost of the acquisition. The great majority of individually reported acquisitions, however, led to the recognition of goodwill. In many cases, the amount assigned to goodwill is small. For twelve transactions, goodwill recognised is less than € 1.0 million, and for a total of 51 transactions, the amount of goodwill recognised is less than € 10 million. Goodwill ranges between € 100 million and € 250 million for 38 companies. In 14 cases, goodwill amounted to more than € 1.0 billion. Surprisingly, for 33 transactions (11%) no information was provided to assist the user in determining whether the transaction resulted in the recognition of goodwill or badwill.

39 Also see IFRS 3 (para. 57) on these points.

The great majority of individually reported acquisitions led to the recognition of goodwill.



36

< 0

(Bad

will

)

0 0.01

to 0

.9

1 to

4.9

5 to

9.9

10 to

24.

9

25 to

49.

9

50 to

99.

9

100

to 2

49.9

250

to 4

99.9

500

to 9

99.9

1000

to

4999

.9

≥ 50

00

Info

rmat

ion

not

disc

lose

d

2 3 3 9 5 13 21 15 10 11 3 2 0 15

Tab. 6 Goodwill resulting from 2005 acquisitions (transactions reported in aggregate, in million €)

Turning to acquisitions reported in aggregate, there are very few cases where the summation of the transactions resulted in a badwill or in zero goodwill. This is not surprising, given that the amounts assigned to badwill are rather small in most cases, so these transactions, as well as those resulting in zero-goodwill, tend to be cancelled out in the aggregate reporting format by transactions yielding relatively larger amounts of goodwill. Nonetheless, we observe that many aggregate sets of transactions lead to rather small amounts of goodwill. The category with the most cases is the € 25 million to € 50 million range (21 cases). However, we also find that two companies report acquisitions in the aggregate that resulted in goodwill of more than € 1.0 billion. For these two cases, it appears likely that some of the transactions subsumed in the respective aggregate may be material in their own right; thus, the individual disclosure format likely would have been more appropriate.

To further analyse the materiality of the amounts assigned to goodwill, we report the ratio of goodwill to the cost of the acquisition. We can compute this ratio for 261 of the 299 individual transactions and for 94 of the 112 sets of acquisitions reported in aggregate. For the other cases, either the cost of the acquisition or the resulting goodwill (or both) is not disclosed. The average ratio for all acquisitions (individually reported transactions and sets of aggregate transactions) is 53%; the standard deviation is 88%. If we exclude the badwill cases from the data set, the average is 60% (standard deviation: 88%).

Figures 18 and 19 demonstrate impressively the importance of goodwill in PPA. In the majority of cases where information is provided, for both individually reported transactions and for the transactions reported in aggregate, the value assigned to goodwill amounts to 50% or more of the total cost of the acquisition(s).40 This is somewhat surprising, given the very far-reaching IFRS rules for the recognition of acquired intangible assets. For 21 individual transactions and for five sets of aggregate transactions, the amounts assigned to goodwill even exceed the cost of the acquisition. This startling result occurs when the net value of the assets acquired minus the liabilities and contingent liabilities assumed is negative.41

40 One rationale that helps explain the high ratios is that companies are required to recognise deferred tax liabilities whenever the fair values of assets acquired (liabilities assumed) at the acquisition date are higher (lower) than the corresponding book values in the balance sheet of the acquiree (fair value adjustments). These deferred tax liabilities accordingly increase the amounts assigned to goodwill. 41 Similarly, there are several cases where the net value of the acquiree is positive, but very small, and the minorities’ proportionate stake in the fair value adjustments is larger than the acquiree’s net value.

In the majority of cases, the value assigned to goodwill amounts to 50% or more of the total cost of the acquisition.



37

45

69

52

15

9

36

14

21

38

0 10 20 30 40 50 60 70 80


100%

75 to 99.9%

50 to 74.9%

25 to 49.9%

10 to 24.9%

0.01 to 9.9%

0

< 0 (badwill)

Fig. 18 Ratio of goodwill to cost of acquisition: Number of individually reported transactions in 2005

Finally, Figure 20 reveals that the relative importance of goodwill varies greatly by industry.42 Acquisitions in the entertainment & media industry lead, on average, with the highest ratio of goodwill to the cost of the acquisition(s). Other industries where acquisitions result in above-average ratios of goodwill to acquisition cost include retail & consumer goods, banks, industrial products and telecommunications. In all of these industries, the proportion of cost allocated to goodwill, on average, exceeds 50%. Industries with below-average ratios of goodwill to acquisition cost include other financial services43, basic materials and pharmaceuticals; in each of these three industry sectors, the ratio is below 30%.

19

34

17

9

5

3

2

5

18

0 5 10 15 20 25 30 35 40


100%

75 to 99.9%

50 to 74.9%

25 to 49.9%

10 to 24.9%

0.01 to 9.9%

0

< 0 (badwill)

Fig. 19 Ratio of goodwill to cost of acquisition: Number of aggregate sets of transactions

42 Before computing industry averages, we eliminated extreme values (i.e., outliers). For some transactions, the acquisition prices are zero or very close to zero. If this is the case, the ratio of goodwill to the cost of the business combination can take on very large positive or negative values. For the computation of the industry averages, we include only cases where the ratio of goodwill to the cost of the business combination is greater than -0.1 and smaller than 1.1. 43 The industry group other financial services comprises, among others, real estate investment and management companies; several acquisitions of such companies have resulted in very small, or zero, goodwill positions.

For acquisitions in the entertainment & media, retail & consumer goods, banking, industrial products and telecommunications industries, the proportion of cost allocated to goodwill, on average, exceeds 50%.

≥

≥



38

27.3%

31.6%

37.8%

38.4%

46.2%

53.9%

54.0%

57.2%

60.4%

67.8%

24.3%

16.0%

0% 10% 20% 30% 40% 50% 60% 70% 80%


Basic Materials

Pharmaceuticals

Utilities

Insurance

Chemicals

Services

Telecommunications

Industrial Products

Banks



Fig. 20 Ratio of goodwill to cost of acquisition by industry

Other Acquisition-Related Disclosures Unless impracticable, companies are required to disclose the revenue and the profit or loss of the combined entity for the complete year as if the acquisition dates for all business combinations completed during that period had occurred at the beginning of the year. This disclosure requirement may be viewed as onerous because the companies’ systems will not normally or easily provide these pro-forma (or “as if”) figures. If it is impracticable to provide this information, companies are required to disclose this fact and provide an explanation as to why this is the case (IFRS 3, para. 70).

Indeed our analysis reveals that less than one-quarter of the companies comply with the pro-forma disclosure requirement. The pro-forma data on revenues and on profit and loss is presented for only 71 of the 299 (24%) individually reported transactions. For the acquisitions reported in aggregate, the proportion of companies disclosing the required information is only slightly higher (29% for pro-forma revenues, 25% for profit or loss). Furthermore, we find that very few of the companies not disclosing the required pro-formas refer to the fact and explain why supplying this disclosure is impracticable. Such explanations were provided for only 16 individually reported transactions (4%) and three sets of transactions reported in aggregate (3%).

Finally, following IFRS 3 (para. 67 (h)), companies are also required to provide “a description of the factors that contributed to a cost that results in the recognition of goodwill ... or a description of the nature of any excess recognised in profit or loss”. This area of disclosure is also relatively problematic. For all cases where goodwill is reported for individual transactions and for aggregate transactions, companies comply with the requirement in only 39% of the cases. Thus, most companies do not provide a rationale for the recognition of goodwill. The minority of companies supplying the required disclosure usually simply expound the motives for the acquisitions and/or refer to expected synergy effects and growth expectations. For only three of the 14 individual transactions and the two sets of aggregate transactions where the excess of the acquirers' interests in the net fair value of the acquirees' assets and liabilities over cost (badwill) are recognised in profit or loss, explanations are provided to assist investors in interpreting the nature of the recognised gains. The lack of an explanation in the other eleven cases is surprising for several reasons. First, as discussed previously, the recognition of badwill is a rather unusual event. Second, the recognition of badwill directly affects profit and loss, and third, badwill can be the result of several different scenarios (“lucky buy”, compensation for expected future losses, or biases in the valuation of fair values of, for instance, deferred tax assets and liabilities). Hence, a detailed explanation of the nature of any badwill, or “excess value”, is likely to be of great interest to financial statement users.

Less than one-quarter of the companies provide the pro-forma disclosures on revenues and on profit and loss. Additionally, most of the companies do not provide a rationale for the recognition of goodwill.



39

3 Significance of Goodwill and Other Intangible Assets on Corporate Balance Sheets In this section, we consider the total goodwill position on our sample companies’ balance sheets, that is, the goodwill resulting from 2005 acquisitions as well as from acquisitions undertaken in prior periods. Furthermore, we analyse the relative importance of other intangible assets, especially those assigned indefinite useful lives.

Our findings highlight the significance of intangible assets, especially goodwill, following the adoption of IFRS throughout Europe. The average intangible asset balance (including goodwill) for the sample companies is € 3.8 billion with a very large standard deviation of € 8.8 billion. Representing a subset of total intangible assets, the average goodwill balance is € 2.5 billion with a standard deviation of € 6.2 billion.

Figure 21 illustrates the magnitude of intangible assets throughout Europe by country and highlights the substantial proportion attributable to goodwill. On average, French (€ 10.3 billion) and German (€ 8.1 billion) companies have the largest intangible asset balances. Consistent with previous sections, the smallest intangible asset balances are found in the Central Eastern European countries (Poland, the Czech Republic, Hungary) with average balances of € 210.5 million or less. The large balances of intangible assets in France and Germany may be linked to the acquisitive nature of several of the companies domiciled in these two countries and the resulting large average goodwill balances (€ 6.5 billion and € 4.0 billion, respectively). For example, a pharmaceutical company and a telecommuni-cations company based in France each had goodwill balances exceeding € 30.0 billion. Four additional French companies operating in various industries had goodwill balances in excess of € 10.0 billion. In Germany, four companies operating in various industries each had goodwill balances in excess of € 10.0 billion.

As reflected in Figure 22, the telecommunications industry by far has the largest average balance for total intangible assets (€ 12.6 billion; standard deviation € 24.2 billion). Indeed the balance is more than double that of the insurance industry which is second in total intangible assets (€ 6.1 billion). A large portion of the total intangibles in the telecommunications industry is attributable to goodwill (€ 8.3 billion). These very large goodwill balances are due to numerous “mega mergers” that occurred in the telecommunications industry over the past decade. Indeed a substantial portion of the goodwill on 2005 balance sheets likely relates to acquisitions undertaken during the second half of the 1990s when the valuations of companies in the telecommunications sector and of other high-tech sectors were highly inflated. While some telecommunications companies had to write off part of the resulting goodwill (as well as licences acquired) due to impairment, substantial portions of the goodwill originating during this period still remain on some balance sheets.

Our findings highlight the significance of intangible assets, especially goodwill, following the adoption of IFRS throughout Europe.



40

54.9

98.9

104.2

303.6

456.5

507.2

703.5

1,263.50

1,378.50

1,293.60

1,507.90

1,714.30

2,673.80

2,462.90

3,767.00

3,994.90

6,504.10

100.3

207.1

210.5

602.6

858.4

1,137.50

1,666.00

1,684.00

1,789.30

3,271.00

2,468.30

3,410.60

3,599.50

5,175.70

8,099.50

10,279.40

445.5

0 2,000 4,000 6,000 8,000 10,000 12,000

Hungary

Czech Republic

Poland

Austria

Finland

Ireland

Denmark

Luxembourg

Sweden

Belgium

Netherlands

Spain

Italy

Switzerland

United Kingdom

Germany

France

In million €

Goodwill Intangibles

Fig. 21 Average goodwill and average intangibles (including goodwill) per company by country in 2005

518.6

987.4

921.6

1,576.60

1,563.10

1,971.80

2,202.60

2,413.20

3,250.60

2,676.90

2,035.40

8,309.50

673.1

1,215.8

1,638.2

2,200.4

2,719.6

3,066.5

3,297.5

4,091.3

5,608.4

6,067.7

12,589.6

2,038.5

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000

Basic Materials


Chemicals

Services

Industrial Products

Utilities



Banks

Pharmaceuticals

Insurance

Telecommunications

In million €

Goodwill Intangibles

Fig. 22 Average goodwill and average intangibles (including goodwill) per company by industry in 2005

If we add back to our sample the 33 companies excluded because they had no goodwill on their 2005 balance sheets and additionally did not engage in M&A activity during 2005, we have a total of 390 companies. Of these, 347 representing 89% report goodwill on their 2005 balance sheets. The large number of companies with goodwill on their balance sheets is particularly noteworthy as prior to the adoption of IFRS, national GAAP of some of the countries represented in our sample allowed companies the option of charging goodwill directly to equity. Hence, some sample companies had zero goodwill at the time

Approximately, 90% of the companies report goodwill on their 2005 balance sheet.



41

of IFRS adoption (i.e., for their 2004 opening IFRS statements) even if they had engaged in significant M&A activity in previous periods.

To ascertain the balance sheet effects of the goodwill balances for our sample, we compute the ratio of goodwill to shareholders’ equity. On average, goodwill represents 41% of shareholders’ equity with a standard deviation of 69%.44 The maximum ratio is for a U.K. based company operating in the retail & consumer goods industry with a goodwill balance that is 886% of shareholders’ equity. With goodwill dwarfing shareholders’ equity, this company, as well as 29 other companies in our sample with goodwill balances that exceed equity, appears extremely vulnerable to any goodwill impairment charges in the future.45

Figure 23 presents goodwill as an average percentage of shareholders’ equity by country. In The Netherlands (58%), the U.K. (58%), Ireland (53%) and France (50%), the ratio exceeds 50%. In Sweden, on average, goodwill as a percentage of equity approaches 50%. On the other end of the spectrum, goodwill has a much lower balance-sheet effect in the Central Eastern European countries (Poland, Czech Republic and Hungary) with a ratio of goodwill to shareholders’ equity of between 4% and 9%.

52.9%50.1% 49.1%

42.9%

36.2% 35.0% 33.7% 33.4% 31.9%28.3%

20.5%16.7%

8.8%5.4%

3.7%

57.7%58.0%

0%

10%

20%

30%

40%

50%

60%

70%

Netherl

ands

United

King

dom

Irelan

d

France

Sweden Ita

ly

German

y

Denmark

Belgium

Finlan

dSpa

in

Luxe

mbourg

Switzerl

and

Austria

Poland

Czech

Rep

ublic

Hunga

ry

Fig. 23 Average percentage of goodwill relative to total equity per company by country in 2005

44 The mean and standard deviation reported here are for the 353 sample companies with zero or positive balances for shareholders’ equity. Four companies were deleted from this analysis because they have negative shareholders’ equity balances. If these four companies are included, the average ratio of goodwill to shareholders’ equity is 39.7%. 45 Interestingly, twelve of these companies are located in the U.K. In addition, four companies have negative shareholders equity, and some of these additionally have relatively high goodwill positions. Three of these four companies are from the U.K.

Goodwill on average represents approximately 40% of shareholders’ equity.



42

58.8%

49.5%44.9%

22.4% 19.7% 18.6% 17.7% 14.9% 14.0%8.9%

71.4%

96.6%

0%

20%

40%

60%

80%

100%

Enterta

inmen

t & M

edia

Retail &

Con

sumer

Goods

Service

s

Teleco

mmunica

tions

Indus

trial P

roduc

ts

Pharm

aceu

ticals

Chemica

ls

Utilitie

s

Other F

inanc

ial S

ervice

s

Banks

Insura

nce

Basic

Materia

ls

Fig. 24 Average percentage of goodwill relative to total equity per company by industry in 2005

Figure 24 reports the ratio of goodwill to shareholders’ equity by industry. The greatest impact is clearly in the entertainment & media industry, where on average goodwill almost equals shareholders’ equity (97%). Goodwill, on average, also exceeds 50% of shareholders’ equity in the retail & consumer goods (71%) and services (59%) industries. Goodwill approaches 50% of shareholders’ equity in the telecommunications industry (50%).

As mentioned previously, intangible assets may be assigned an indefinite useful life if there is no foreseeable limit on the period over which the asset will generate cash flows for the entity. Approximately 20% of our sample (74 companies) report intangible assets assigned indefinite useful lives (other than goodwill) on their balance sheets or provide detailed disclosure, including information regarding the assigned values, in their notes. In several other cases companies refer to intangible assets with indefinite useful lives in their footnotes. However, their remarks are vague so that the amounts can not be ascertained or it remains unclear to the outside user whether these companies have such assets on their balance sheets. For instance, some companies explain in their accounting policy footnotes the rules for the recognition and valuation of intangible assets with indefinite useful lives, but make no further mention of such assets in the footnotes or on the face of the balance sheet. Where detailed information is given, we find that intangible assets with indefinite useful lives are often related to brands or licences acquired through acquisitions.

Intangibles with indefinite useful lives were most frequently reported by U.K. (13), French (9) and Italian (9) companies. Nineteen of the companies reporting intangibles assigned indefinite useful lives operate in the retail & consumer goods industry, and 13 operate in the entertainment & media industry. A telecommunications company based in Germany reported the largest balance of € 17.0 billion for intangible assets with an indefinite useful life (e.g., U.S. mobile communications licences). Three companies reported balances falling between € 4.3 and € 4.6 billion. These include two U.K. companies operating in the retail & consumer goods industry and a French company operating in the telecommunications industry. The amounts assigned to intangibles with indefinite useful lives of these five companies are much larger than all others in our sample as the next largest balance for intangibles assigned indefinite useful lives is € 2.4 billion, and the average balance for the 74 companies is only € 0.8 billion. Like goodwill, other intangibles assigned an indefinite useful life are not amortised and must be reviewed at least annually to determine whether they have maintained their value.

In the entertainment & media industry, goodwill on average almost equals total shareholders’ equity, and in the retail & consumer goods, services and telecommunications industries goodwill either approaches or exceeds 50% of total equity.



43

4 Impairment Losses and Reversals of Impairment Losses for Goodwill and Other Intangible Assets This section presents our analysis of the 2005 IFRS disclosures associated with impairment of goodwill and other intangible assets.46 According to IAS 36 (para. 126), companies are required to disclose information on impairment losses (and reversals) recognised during the reporting period for each class of asset. As part of our empirical study, we collected and thoroughly analysed the disclosures associated with impairment charges on the various classes of intangible assets and additionally collected similar information for tangible assets. Of the 357 sample companies, 246 (69%) reported impairment charges during 2005. Figure 25 reveals that 64 companies reported only on impairment of tangible assets, 60 only on impairment of goodwill and other intangible assets, and 122 companies on impairment of both tangible and intangible assets (including goodwill).

Before focusing on impairment losses associated with goodwill and other intangible assets, we provide a brief overview of our key findings for impairment losses associated with tangible assets. For the 186 companies reporting impairment losses on tangible assets, the average impairment charge was € 48 million, the standard deviation was € 92 million. Industries with the highest average impairment losses on tangible assets are utilities (€ 126 million) and basic materials (€ 78 million). Countries with relatively high average impairment charges for tangible assets include Germany (€ 101 million), the U.K (€ 86 million), Finland (€ 68 million) and The Netherlands (€ 66 million).

No impairment; 111; 31%

Impairment of both tangible assets and

goodwill and other

intangible assets;

122; 34%

Impaiment of tangible

assets only; 64; 18%

Impairment of goodwill and

other intangible

assets only; 60; 17%

Fig. 25 Number of companies recognising impairment losses in 2005

46 Our data set does not address impairment of financial assets. Furthermore, according to IAS 40, para 30, companies may select to use either the cost model or the fair value model for the measurement of investment property subsequent to initial recognition. The impairment test and related disclosures according to IAS 36 only apply to companies choosing the cost model, not to those using the fair value method. Some sample companies use the fair value model; others use the cost model. Therefore, to prevent possible bias, we also excluded impairment of investment property from the scope of our study. Finally, our analysis addresses only goodwill associated with fully consolidated subsidiaries. Thus, goodwill and goodwill impairment associated with joint ventures or associates (per IAS 31 and IAS 28) are not included in the scope of our study.

Approximately, 70% of the companies reported impairment charges in 2005.



44

Impairment of goodwill; 113; 32%

No impairment of

goodwill; 244; 68%

Fig. 26 Number of companies recognising goodwill impairment losses in 2005

Our findings regarding impairment losses associated with goodwill and other intangible assets are summarized in Tables 7 and 8.47 About one-third of the sample companies (113 companies) recognised impairment charges during 2005 associated with goodwill (also see Figure 26). The average charge to net income is € 358 million. The most frequent instances of goodwill impairment charges are, especially in relation to the size of the country sub-sample, for companies based in France: Twenty-five of the 34 French companies (74%) included in our sample reported goodwill impairments in 2005. Other countries with high occurrences of goodwill impairment are the U.K. (19 companies) and Italy (eleven companies).

U.K. companies by far reported the highest average impairment charge during 2005 for goodwill at € 1.9 billion. This however is due primarily to one extreme case – a € 34.2 billion goodwill impairment charge reported by a British telecommunications company. Excluding this “outlier” from the U.K. sub-sample, the average U.K. impairment loss shrinks dramatically to € 66 million. The German sub-sample also has a very high average impairment loss of € 501 million due to seven cases of goodwill impairment; four of these are very large charges exceeding € 300 million. Second only to the U.K. outlier, included in the German sub-sample are a € 1.9 billion impairment loss by a telecommunications company and a € 814 million impairment loss by an utility.

Table 8 gives additional insight into goodwill impairment charges by providing an industry perspective. Clearly the companies most heavily impacted are those operating in the telecommunications industry where, for companies recognising goodwill impairment losses, the average charge was € 4.0 billion. However, this average value is driven by the above described extreme cases of a U.K. company and a German company required to write down their goodwill positions by € 34.2 billion and € 1.9 billion, respectively. The remaining seven impairment cases in the telecommunications industry are much less severe, with charges falling between € 0.3 million and € 42 million. Besides the telecommunications industry, other sectors with relatively large average impairment losses include the services (€ 157 million), other financial services (€ 116 million) and utilities (€ 105 million) industries.

47 When computing the statistics presented in Tables 8 and 9, we excluded eight cases. These companies recognised impairment charges for intangibles in their 2005 financial statements. However, it was not possible to determine to which class(es) of intangibles these charges were related. All eight charges were relatively small. In three cases, the amount was less than € 1 million. In the other cases the charges ranged between € 2 million and € 24 million.

About one-third of the companies recognised impairment charges during 2005 associated with goodwill. The average charge to net income is € 358 million.

The industry most heavily impacted by goodwill impairment charges is telecommunications. However, the average charge is driven by two extreme cases of a U.K. and a German company reporting charges of € 34.2 billion and € 1.9 billion, respectively.



45

Country Total sample size

Companies reporting goodwill impairment

Average goodwill impairment loss (in million €)

Companies reporting impairment on intangible assets with definite lives

Average impairment loss on intangible assets with definite lives (in million €)

Companies reporting impairment on other intangible assets with indefinite lives

Average impairment loss on other intangible assets with indefinite lives (in million €)

Austria 16 5 2.5 2 0.5 Belgium 16 5 6.5 7 11.9

Czech Republic 6 1 0.7 4 11.7 Denmark 14 5 24.5 5 94.4

Finland 21 5 13.0 1 1.0 France 34 25 31.0 10 160.6 2 18.6

Germany 21 7 501.2 14 24.1 2 17.0 Hungary 6 2 0.1 1 19.6

Ireland 14 2 1.1 1 0.5 Italy 33 11 8.0 11 11.7 1 1.3

Luxembourg 4 1 3.7 2 7.0 Netherlands 18 6 23.5 10 7.1

Poland 13 4 12.7 7 19.8 1 0.2 Spain 28 7 2.1 12 29.4

Sweden 20 5 10.3 6 2.9 Switzerland 18 3 62.2 5 75.1

United Kingdom 75 19 1,861.0 14 42.8 2 126.2

Total 357 113 357.6 112 38.1 8 40.6

Tab. 7 Impairment losses recognised for intangible assets by country in 2005

Industry Total sample size

Companies reporting goodwill impairment

Average goodwill impairment loss (in million €)

Companies reporting impairment on intangible assets with definite lives

Average impairment loss on intangible assets with definite lives (in million €)

Companies reporting impairment on other intangible assets with indefinite lives

Average impairment loss on other intangible assets with indefinite lives (in million

€) Banks 45 16 14.2 17 22.9

Basic Materials 18 7 5.7 6 31.0 Chemicals 14 3 9.2 6 13.0 1 36.1

Entertainment & Media 29 9 18.8 8 6.1 2 0.7

Industrial Products 61 26 21.5 13 29.6

Insurance 22 8 33.9 10 22.9 Other Financial

Services 14 4 115.6 1 11.9 Pharmaceuticals 17 2 2.2 6 244.3 1 1.5

Retail & Consumer Goods 53 14 46.8 17 6.0 2 127.5

Services 20 5 156.5 5 113.0 1 1.0 Telecom-

munications 26 9 4,019.0 14 52.3 1 30.0 Utilities 38 10 104.6 9 7.9

Total 357 113 357.6 112 38.1 8 40.6

Tab. 8 Impairment losses recognised for intangible assets by industry in 2005



46

The impairment charges associated with other classes of intangible assets are on average much smaller than those associated with goodwill. The average impairment charge was € 38 million for the 112 companies writing down intangibles with definite useful lives and € 41 million for the eight cases related to other intangibles with indefinite useful lives. From a country perspective, the largest average charges for intangibles with definite useful lives were for French (€ 161 million) and Danish (€ 94 million) companies. From an industry perspective, average impairment charges for intangibles with definite useful lives were the largest in the pharmaceuticals industry at € 244 million; this is mainly due to two large impairment charges taken by a French (€ 966 million) and a Swiss pharmaceuticals (€ 334 million) company.

Turning to intangibles with indefinite useful lives, there are only eight impairment cases for the entire sample (11% of the 74 companies reporting intangibles with indefinite lives). One of these dwarfs all others, a € 251 million impairment loss at a U.K. retail & consumer goods company. The other seven cases are much smaller, the second largest amount being only € 36 million.

IFRS prohibits the recognition of self-generated goodwill. Therefore, all the goodwill impairment losses reported in our study are related to acquired goodwill. Furthermore, IFRS allows recognition of other self-generated intangible assets only under very restrictive conditions.48 Therefore, the vast majority of impairment losses on intangible assets recognised under IFRS in 2005 are most likely related to acquisitions. The frequency of impairment charges and the sometimes extreme amounts again illustrate that acquisitions under the new IFRS (and U.S. GAAP) merger accounting rules lead to a danger of sudden and highly visible earnings shocks.

IAS 36 (para. 126) also requires companies to disclose the amount of reversals of impairment losses recognised in net income during the period. A reversal takes place if there has been a change in the estimates used to determine the asset’s recoverable amount since the company has recognised the impairment loss. If this is the case, the carrying amount of the asset is increased. However, the carrying amount must not exceed the value that would have been determined if there had been no impairment loss in prior periods.49 The reversal is recognised as a gain in the income statement. Finally, it is important to recall within this context that IFRS prohibits reversals of impairment losses for goodwill.50

For tangible assets, 71 companies reversed impairment losses in the income statement. For intangibles, the number of impairment reversals is only 23. The average amount reversed through profit and loss is € 32 million for tangible assets and € 6 million for intangibles. As illustrated in Table 9 the number of reversals is relatively high for French companies, both for reversals of impairment losses on tangible assets (10 cases, average: € 135 million) and intangible assets (five cases, average: € 13 million).51 Additional insights into reversed impairment losses by industry are given in Table 10.

48 For details, see IAS 38 (paras. 51 to 64). 49 See IAS 36 (paras. 114 and 117). 50 See IAS 36 (para. 124). 51 The above averages for impairment losses and reversals for French companies could be due to the nature of French compa-nies’ acquisition strategies. Second, in principle they could reflect an unusally volatile business environment within which French companies operate. Third, they could also be the result of a more “dynamic” application of IAS 36 in France in comparison to the practices in other European countries included in our sample.

Impairment charges associated with other classes of intangible assets are on average much smaller than those associated with goodwill.

The frequency of impairment charges, and the sometimes extreme amounts, illustrate that acquisitions under the new IFRS merger accounting rules lead to a danger of sudden and highly visible earnings shocks.



47


Companies reporting reversals of impairments for tangible assets

Average reversals of impairments for tangible assets (in million €)

Companies reporting reversals of impairments for intangible assets with definite lives

Average reversals of impairments for intangible assets with definite lives (in million €)

Austria 16 5 0.4 2 0.5 Belgium 16 4 5.9 1 1.9

Czech Republic 6 2 7.8 2 0.6 Denmark 14 1 25.6

Finland 21 1 1.0 France 34 10 135.2 5 12.8

Germany 21 8 5.3 2 2.0 Hungary 6 1 8.3 1 0.1

Ireland 14 Italy 33 5 13.3 4 6.0

Luxembourg 4 2 49.0 1 10.0 Netherlands 18 3 12.5

Poland 13 6 4.5 3 2.9 Spain 28 8 26.7 1 0.5

Sweden 20 4 10.6 Switzerland 18 2 6.4

United Kingdom 75 9 29.6 1 16.0 Total 357 71 31.5 23 5.7

Tab. 9 Reversals of impairment losses recognised by country in 2005


Companies reporting reversals of impairments for tangible assets

Average reversals of impairments for tangible assets (in million €)

Companies reporting reversals of impairments for intangible assets with definite lives

Average reversals of impairments for intangible assets with definite lives (in million €)

Banks 45 9 121.2 5 1.2 Basic Materials 18 6 19.3 1 16.0

Chemicals 14 4 4.2 Entertainment &

Media 29 6 5.9 4 8.3 Industrial Products 61 13 22.3 3 7.1

Insurance 22 4 14.9 1 0.1 Other Financial

Services 14 1 1.0 Pharmaceuticals 17 2 2.5

Retail & Consumer Goods 53 7 32.3 1 1.0

Services 20 5 12.8 Telecommunications 26 3 17.1 2 1.3

Utilities 38 11 25.4 6 8.5 Total 357 71 31.5 23 5.7

Tab. 10 Reversals of impairment losses recognised by industry in 2005

5 Testing Goodwill for Impairment This final section reports our findings on how sample companies conduct their impairment testing for goodwill. Specifically we address how the companies allocate goodwill to cash



48

generating units (CGUs), when they conduct impairment testing throughout the year, whether they compare the carrying amount of the CGUs containing goodwill with “fair value less cost to sell” or with “value in use”, or in some instances a combination of both; and how they estimate the respective values for the recoverable amount.52

As explained in part C, goodwill cannot be separately tested for impairment. Goodwill does not generate cash inflows independently of other assets and cannot be separated from the company and sold in the market. Therefore, when determining the recoverable amount for goodwill impairment testing, neither the value in use nor the fair value of goodwill can be determined in isolation. Instead, at the time of acquisition, goodwill is allocated to the CGUs of the combined companies expected to benefit from the goodwill in the future. Impairment testing then is conducted on the level of the CGUs to which the goodwill is allocated.

In presenting our findings, we first describe how the sample companies allocate goodwill to the appropriate CGUs. We believe external users of financial statements can only fully comprehend the allocation of goodwill and subsequent impairment testing for goodwill if the company discloses adequate information regarding the structure of its CGUs, especially those CGUs containing goodwill. Ideally a company should explain how CGUs are defined (e.g., product lines, geographical segments, legal entities, plants, etc.), the number of CGUs comprising the company and the number of CGUs containing goodwill. However, as explained previously, disclosure of these items of information is not mandatory under IFRS. According to IAS 36 (para. 134), companies are only required to disclose rudimentary information on CGUs containing significant amounts of goodwill (or other intangibles assigned indefinite lives). According to IAS 36 (para. 130), more detailed information is required only for those CGUs where material impairment losses have been recognised.

32

27

35

28

1614

96

18

6 6

25

20

0

5

10

1520

2530

3540

1 2 3 4 5 6 7 8 9 10

11 to

15

16 to

20 > 20

Number of cash generating units containing goodwill

Num

ber o

f com

pani

es

Fig. 27 Number of cash generating units disclosed as containing goodwill per company in 2005

52 The disclosure requirements are basically the same for CGUs containing significant amounts of goodwill and for those containing other intangible assets assigned indefinite useful lives. However, as discussed above, the number of companies reporting they have intangible assets with indefinite useful lives on their balance sheets is relatively small. Therefore, in our discussion, we concentrate on disclosures for CGUs containing significant amounts of goodwill.

We believe that ideally a company should explain how CGUs are defined, the number of CGUs comprising the company and the number of CGUs containing goodwill. However, disclosure of these items of information is not mandatory under IFRS.



49

5348

33

15

3 1 1

5651

0

10

20

30

40

50

60

1 2 3 4 5 6 7 9 11

Number of cash generating units containing significant goodwill

Num

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Fig. 28 Number of cash generating units disclosed as containing significant goodwill per company in 2005

In our sample, 347 of the 357 companies report goodwill on their balance sheets. About two-thirds of the companies with goodwill (243, or 70%) voluntarily disclose the total number of CGUs containing goodwill.53 As depicted in Figure 27, a relatively large number – 20 companies – indicate goodwill is allocated to only one CGU. In most companies, goodwill is allocated to very few CGUs, normally between two to six. Only 30 companies (12%) allocate goodwill to more than 10 CGUs. In two extreme or “outlier cases”, companies report that goodwill is allocated to 47 and 50 CGUs, respectively. Both of them – a Spanish telecommunications company and a Swiss retail & consumer goods company – are very large companies with very high goodwill balances.

Figure 28 shows the number of CGUs reported as containing significant goodwill. This graph provides strong evidence confirming that goodwill for most of our sample companies is concentrated in a very small number of CGUs, in most cases five or less. Fifty-one companies report that only one CGU contains a significant amount of goodwill.

The high proportion of companies with (significant) goodwill allocated to only one or very few CGUs may at first seem surprising. However, it is important to understand that the structure of CGUs within companies likely differs for “normal” impairment testing (e.g., for tangible assets - property, plant and equipment) and impairment testing of goodwill. CGUs are defined in IAS 36 as the “smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets”.54 Thus, the definition of a CGU follows a bottom-up approach, and large, diversified companies may indeed be comprised of very large numbers of CGUs. Goodwill, on the other hand, is allocated to the lowest organisational level within the company for which goodwill is monitored for internal management purposes.55 Here, the standard alternatively takes a top-down approach. Therefore, the number of CGUs containing goodwill may be much smaller than the total number of CGUs in any given company.

The fact that (significant) goodwill in many companies is allocated to only one or very few CGUs may additionally be due to companies being active in primarily one market, or to companies following highly focused acquisition strategies. However, we should also note that a certain degree of judgement is required when goodwill is allocated to the acquirer’s CGUs “expected to benefit from the synergies of the combination”, as required by IAS 36 (para. 80). The existence of relatively few and highly aggregated CGUs for goodwill

53 Ninety-one companies (25.4%) voluntarily disclosed the total number of CGUs. 54 See IAS 36 (para. 6). 55 However, as noted before, the CGU’s goodwill is allocated to must not exceed the number of primary or secondary segments reported by the company; see IAS 36 (para. 80 (b)).

For most companies, goodwill is concentrated in a very small number of CGUs, in most cases five or less.



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impairment testing reduces the probability of future impairment losses due to diversification effects.56 Another effect is a reduction of efforts required to conduct the test in subsequent periods .

For 268 of the 347 companies reporting goodwill on their balance sheets (77%), the information presented in the footnotes allows us to determine how CGUs have been defined for the purpose of allocating goodwill. As depicted in Figure 29, a high proportion of the companies (93 or 35%) define CGUs along product lines. Twenty-seven companies (10%) define CGUs using geographic criteria. Seventy-one companies (27%) use the legal entity structure to distinguish CGUs. The remaining companies, 77 (29%) use a combination of criteria. In most instances, these companies combine product lines and geographical criteria, or product lines and legal criteria.

71

4134

2

93

27

0

20

40

60

80

100

Product /Business

Region /Geographical

Legal entity Product &Region

Product &Legal entity

Region &Legal entity

Num

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f com

pani

es

Fig. 29 Classification criteria for determining cash generating units in 2005

Most companies, when allocating goodwill to CGUs, utilise the top hierarchical level (i.e., the most aggregated) allowed by IAS 36 (para. 80 (b)). Specifically, they allocate goodwill to CGUs based on the company’s primary or secondary segment reporting format. This holds true for 165 of the 252 (66%) companies that provide this information in the footnotes. Approximately 30% of the companies (75) allocate goodwill to CGUs on levels below the segment reporting format. The remaining twelve companies (5%) use a combination of segment level CGUs and CGUs representing lower levels than the segment reporting format.

Timing of Goodwill Impairment Tests We began our examination of goodwill impairment testing by collecting information from the footnotes regarding when the impairment tests were conducted during the year. IAS 36 specifies that the annual goodwill impairment test “may be performed at any time during an annual period, provided the test is performed at the same time every year”.57 The standard furthermore allows companies to conduct impairment tests of different CGUs at different times during the year.

In addition to the regular annual test, companies are required to perform an impairment test whenever there is an indication that a CGU containing goodwill may be impaired. Although numerous sample companies explain in their accounting policy footnotes the

56 Also see Pellens, B. / Sellhorn, T. (2001), Neue Goodwill-Bilanzierung nach US-GAAP – Der Impairment-Only Approach des FASB –, in: Der Betrieb, Vol. 54, No. 14, p. 719 on this point. 57 See IAS 36 (para. 96).

About two-thirds of the companies, when allocating goodwill to CGUs, utilise the top hierarchical level allowed by IAS 36 (i.e., the company’s primary or secondary segment reporting format).



51

types of “triggering events” that might in principle lead to additional impairment testing, we did not identify any cases where companies specifically disclose that they performed additional, “trigger-based” impairment tests.

IAS 36 does not explicitly require companies to provide information on the timing of the annual test. However, para. 103 (a) of the standard indicates companies are to “present information about the basis of the presentation of the financial statements and the specific accounting policies used”. IAS 1 (para. 108) adds that the measurement bases utilised in preparing financial statements and “the other accounting policies used that are relevant to an understanding of the financial statements” shall be disclosed in the footnotes.

As mentioned above, 347 of the 357 sample companies have goodwill on their balance sheets. Of these, 205 companies disclose the timing of their goodwill impairment tests. By far, most companies perform the test at, or shortly before, the balance-sheet date. Another 14 companies regularly perform the impairment test during the fourth quarter. Twelve companies conduct the impairment test at another time such as the half-year balance-sheet date. Given the complexity of the task and the time and cost involved, it is somewhat surprising that five companies appear to voluntarily perform the test at more than one time during the year (for instance, mid-year and year-end, or at year-end and each interim reporting date).

The annual goodwill impairment test is performed … Number of companies (n = 205) … at, or shortly before, the balance-sheet date. 170

… at the half-year balance-sheet date. 5 … during the first quarter. 1

… during the second quarter. 1 … during the third quarter. 5

… during the fourth quarter. 14 … at more than one time during the year. 5

Precise timing of annual goodwill impairment test is not disclosed. 4

Tab. 11 Disclosed timing of goodwill impairment testing in 2005

Overall, we find it somewhat surprising that so many companies elect to perform the goodwill impairment test at the balance-sheet date. For most companies’ accounting departments (and most auditors) year-end is a time of extreme work loads and time pressure. Thus, one would expect companies to shift demanding and time-consuming tasks such as goodwill impairment testing to other time periods, if possible. Furthermore, as discussed in more detail below, goodwill impairment testing relies on forward-looking information contained in a company’s mid- to longer-term financial and business plans. Thus, to prevent unnecessary replication of work it appears rational to coordinate the timing of impairment testing with the planning cycle of the company.58

Measuring Recoverable Amount of CGUs – “Fair Value less Costs to Sell” Versus “Value in Use” As explained above, impairment testing according to IAS 36 involves a comparison of the carrying amount of an asset or a CGU carrying goodwill with its recoverable amount. The recoverable amount is defined as the higher of the asset’s fair value less costs to sell and its value in use. IAS 36 emphasises (see para. 19) it is not necessary to determine both

58 See Epstein, R. / Pellens, B. / Ruhwedel, P. (2005), Goodwill bilanzieren und steuern, Deloitte Consulting, Frankfurt am Main 2005. Also see Pellens, B. et al. (2005), Goodwill Impairment Test – ein empirischer Vergleich der IFRS- und US GAAP-Bilanzierer im deutschen Prime Standard, in: BB-Special 10/2005 Goodwill-Bilanzierung, Supplement to Betriebs-Berater, Vol. 60, No. 39, pp. 10-18.



52

values. If either of the two measures exceeds an asset’s carrying value, the asset is not impaired, and the company is not required to estimate the other measure.

Companies are additionally required to disclose information about the estimates used to measure the recoverable amount for all CGUs containing goodwill significant in comparison to the company’s total recognised goodwill.59 As shown in Figure 30, 288 companies disclose this information (i.e., 83% of companies with goodwill balances). A majority – 238 companies (68% of companies with goodwill balances) – report that impairment testing of CGUs containing goodwill is based on estimates of value in use only. Thirteen companies (4%) only use fair value less costs to sell, and 37 companies (11%) employ both valuation methods to determine the recoverable amount. Fifty-nine companies (17%) do not report any information.

Value in use; 238; 68%

Fair value less costs to sell and value in

use; 37; 11%

Information not provided;

59; 17%

Fair value less costs to sell;

13; 4%

Fig. 30 Basis for measurement of recoverable amount for goodwill impairment testing – Fair value less costs to sell versus value in use in 2005

Value in use is the most frequently used method to measure recoverable amount because it is normally very difficult to determine the fair value less costs to sell of a CGU. According to IAS 36,60 the best evidence of an asset’s (or a CGU’s) fair value is a price in a binding sales agreement in an arm’s-length transaction. If no such agreement exists but the asset is traded in an active market, the best estimate for fair value is the asset’s market price. For CGUs, however, normally neither a binding sales agreement nor an active market exists. In such circumstances, the company estimates fair value less costs to sell based on “the best information available to reflect the amount that an entity could obtain, at the balance-sheet date, from the disposal of the asset in an arm’s length transaction between knowledgeable, willing parties, after deducting the costs of disposal”.61 IAS 36 adds that companies, in estimating fair values, are to consider the outcome of recent transactions for similar assets within the same industry. However, since CGUs are typically highly idiosyncratic combinations of factors of production, identifying transactions for “similar assets” is often difficult or impossible.

Application of Fair Value Method Fifty companies report that they use fair value less cost to sell to determine the recoverable amount of CGUs containing goodwill either as the sole method or in combination with value in use. No country or industry trend emerges as the companies

59 See IAS 36 (para. 134). 60 See IAS 36 (paras. 25 to 27, in combination with para. 74). 61 IAS 36 (para. 27).



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using the fair value method appear to be randomly distributed over our country and industry sub-samples. Forty-five of the 50 companies give an explanation as to the methodology used to estimate fair value less costs to sell.62 Twenty-one companies refer to the use of multiples (i.e., multiples based on recent transactions, stock market valuations, earnings, or EBIDTA). One might question the reliability of valuations based on simple multiples, especially in cases where multiples appear to be the only method used to determine the fair values of CGUs. However, some companies explain that multiples are employed only to validate other valuation methods. In other cases, fair values are based on the stock prices of listed subsidiaries. Seven companies estimate fair values using the discounted-cash-flow method. Several companies refer to other, sometimes industry-specific valuation approaches. Moreover, some companies explain that the fair values are obtained from external, independent valuation consultants.

Finally, we note that some of the explanations describing the fair value estimation methodology are not fully satisfactory. Some companies simply state they refer to “market values”, “market prices or best estimates of the selling price”, “best estimations of fair values”, or use other tautological phrases. In other cases, companies explain that they simply use the purchase prices for companies acquired during the reporting period.

7

12

4

8

5

18

0 2 4 6 8 10 12 14 16 18 20

Other valuation methods

External valuation

Discounted-cash-flow method

Other references to multiples method

Stock-market-based multiples

Transaction-based multiples

Number of companies

n = 45, multiple answers allowed

Fig. 31 Methods used to estimate CGU fair values in 2005

Transparency can also be improved with respect to other disclosure requirements prescribed by IAS 36 for companies using fair value less costs to sell to measure the recoverable amount for CGUs containing significant goodwill positions. Unless fair values are determined by observable market prices for the units, according to IAS 36 (para. 134 (e)), companies are required to disclose descriptions of the key assumptions used to estimate the fair values, as well as descriptions of “the approaches to determining the values assigned to these assumptions”. These requirements are probably applicable for all but a few cases where fair values estimations are based on stock prices of listed subsidiaries. However, of the 50 companies using fair value less costs to sell to determine the recoverable amounts of CGUs containing goodwill, only 18 companies (36%) provide the prescribed information on the key assumptions.

62 The numbers reported do not add to 45 since some companies disclosed several valuation methods.



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Application of Value-in-Use Concept: Disclosure Requirements Determining value in use of an asset or a CGU involves the following steps: 1) estimating the future cash inflows and outflows to be derived from continuing use of the asset or the CGU and from its ultimate disposal and 2) applying the appropriate discount rate to calculate the net present value of those future cash flows. In estimating future cash flows, companies are required to differentiate between projections over a near to mid term horizon covered by the company’s most recent financial budgets.63 Projections beyond this horizon are based on expected steady or declining growth rates (terminal values).

According to IAS 36 (para. 134 (d)), companies that employ value in use to determine the recoverable amounts of CGUs have to disclose detailed information on this estimation for each CGU that contains significant portions of the company’s overall goodwill balance.

More precisely, among other things, the following disclosures are required:

● a description of each key assumption used to forecast cash flows for “the period covered by the most recent budgets/forecasts”;

● a description of management’s approaches to determining the values assigned to each key assumption;

● the period over which management has projected cash flows based on financial budgets/forecasts approved by management;

● the growth rate used to extrapolate cash flow projections beyond the period covered by the most recent budgets/forecasts;

● the discount rates applied to the cash flow projections.

As mentioned previously, 275 companies report that they use the value-in-use method to estimate the recoverable amount of CGUs containing goodwill. Of these 238 companies apply value in use as the sole method. An additional 37 apply value in use parallel to estimations of fair values. Almost two thirds (172, or 63%) of the companies utilising value in use provide the required description of the key assumptions used to forecast cash flows for the period covered by the most recent budgets/forecasts. Many companies fulfill this disclosure requirement by providing lists or tables of key assumptions.

The second disclosure requirement, the description of management’s approaches to determining the values assigned to each key assumption, is fulfilled by just over half the companies (159 or 58%). Most companies (225, or 82%) disclose the planning period for the cash flows based on approved financial budgets or forecasts. Information concerning the growth rate underlying the calculation of the terminal values is reported by 174 companies (63%). Finally, 220 companies (80%) report the discount rate applied to the projected cash flows.

To summarise, a majority of our sample companies provide all the required disclosure items with respect to value-in-use estimations for CGUs containing goodwill. However, a sizable proportion of companies do not provide all of the prescribed disclosures, and some do not provide any of the required disclosures. This is regrettable as financial statement users can assess the efficacy and rigour, and accordingly the reliability, of impairment testing for goodwill (and other intangible assets assigned indefinite lives) only if the models, assumptions and parameters underlying these tests are disclosed.

63 See IAS 36 (para. 35): The period should not exceed five years, except the company can demonstrate its ability to forcasts cash flows accurately for longer periods.



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Value-in-Use Concept: The Planning Period The discounted-cash-flow method is the standard method utilised by investment bankers, consultants, and other professionals for the valuation of projects and businesses.64 Usually, two phases are distinguished with respect to determining the expected future cash flows to be discounted. In the first phase, typically covering three to seven years, the cash flows are forecasted in detail on a year-by-year basis. The second phase covers the remaining life-time of the project or the business. For this long-term horizon, precise yearly forecasts are usually not attempted. Instead, a continuous cash flow stream is normally assumed using either a constant annual cash flow stream or a stream with a (constant or declining) growth rate.

The procedure prescribed in IAS 36 for the estimation of the value in use of assets and CGUs follows this two-stage concept. IAS 36 (para. 35) states:

“Detailed, explicit and reliable financial budgets/forecasts of future cash flows for periods longer than five years are generally not available. For this reason, management’s estimates of future cash flows are based on the most recent budgets/ forecasts for a maximum of five years.”

As mentioned above, companies employing value in use to determine the recoverable amount of CGUs are required to disclose the period covered by the cash flow forecasts.65 This disclosure is provided by 225 of the sample companies. As expected, the planning horizons vary greatly not only between firms, but also within some firms for different CGUs (i.e., 21 companies report several planning horizons or ranges of years). The companies’ disclosures are summarised in Figure 32.66 Most companies (114; 50%) make detailed yearly cash flow forecasts for a five year period which represents the horizon IAS 36 suggests as the maximum time frame.

61

20

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24

4 346

0

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0

Inform

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isclos

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n = 225, multiple answers allowed

Fig. 32 Application of value-in-use method: Planning period in 2005

64 For details, see for instance, Brealey, R. A. / Myers, S. C. / Allen, F. (2006), Principles of Corporate Finance, 8th edition. 65 See IAS 36 (para. 134 (d) (iii)). 66 When summarising the companies’ disclosures in Figure 32, we allow for multiple answers. For companies reporting ranges (i.e., three to five years), we count all years within the range. If companies report that their planning horizons cover more than, for example, five years, these companies are counted as using horizons between six and ten years.



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The shortest planning horizon disclosed as the cash flow estimation period is a one-year horizon, which is utilised by six companies.67 This, of course, is a very short forecasting timeframe resulting in a very high proportion of the CGU value being captured in the terminal values. Furthermore, the detailed annual cash flow forecasts for the first valuation phase form the basis for the estimation of the continuous cash flows assumed for the second phase (terminal value). Thus, we believe a detailed cash flow planning horizon of only one year makes the extrapolation of the continuous cash flow very difficult and rather unreliable.

Representing the other extreme, 28 companies (12%) exceed the maximum timeframe of five years suggested for detailed financial forecasts by IAS 36.68 Twenty-four companies employ detailed cash flow plans of six to ten years, and four companies even exceed a ten year forecast period when using the value-in-use method for the valuation of CGUs containing goodwill. Of these, as required by IAS 36 (para. 134 (d) (iii)), 21 provide an explanation regarding why periods longer than five years are justified. These explanations normally refer to finite planning periods for certain projects or to durations of exploration rights, patents, licences, etc.

Value-in-Use Concept: Terminal Value and Long-Term Growth Expectations When performing a valuation of assets, companies or CGUs, a major proportion of the total value normally results from the discounted value of the cash flows expected beyond the detailed planning period (terminal value). For example, assuming a discount factor of 10%, the net present value of the first five years of a constant eternal annual income stream makes up only 38% of the total net present value; the remaining 62% of the net present value is associated with the terminal value. If the cash flows are growing and not constant, or if the discount rate is lower than 10%, the relative weight of the terminal value is even higher.69 Therefore, estimating parameters for the terminal value is crucial for the determination of the value in use of CGUs.

Most sample companies providing an explanation on this point, use the standard terminal value model with an expected basis cash flow and a growth rate (the third key parameter – the discount rate – is discussed below). The basis cash flow is usually extrapolated from the cash flows forecasted for the final years of the detailed planning period. The growth rate should reflect the expected long-term sustainable growth of the CGU’s cash flows. Nominal growth from inflation must be considered in this context since most valuation models employed in corporate practice are based on nominal cash flow forecasts and nominal discount rates. The standard valuation model assumes an indefinite time horizon for the cash flows underlying the terminal value. Therefore, the (eternal) growth rate should not exceed the expected long term (nominal) growth rate of the CGU’s sector, or indeed, the long term growth rate of the economy as a whole.

Of the 275 sample companies employing value in use to estimate recoverable amounts of CGUs containing goodwill, 174 (63%) disclose information on the growth rate underlying the calculation of terminal values. The growth rates vary significantly between companies, and as with the planning rates, many companies differentiate growth rates for different CGUs. While some companies precisely disclose growth rates (and other key parameters) per CGU, often in tabular form, others only provide summaries by giving ranges of the growth rates used. These ranges can be very broad (e.g., certain companies report ranges

67 The six companies include three banks, two retail and consumer goods companies, and one telecommunication’s company. Three of the companies are based in the U.K.; one each is based in Ireland, Italy and Switzerland. 68 We do not discern any country pattern for the 21 companies. From an industry perspective, there are four utilities companies, four services companies, three retail and consumer goods companies, three telecommunications companies, two basic materials companies, two banks and three companies from other sectors. 69 S See IDW (2002), WP Handbuch, 12th edition, Volume II, Abschnitt A, para. 185.



57

from 3% to 4%, from 2% to 9%, or from 2% and 11%), and some companies do not give any further explanation as to when or how the individual rates are applied. In these cases, the companies’ goodwill impairment tests are not fully transparent and understandable to outside users of financial statements.

Figure 33 presents the maximum growth rates reported by the companies providing the relevant disclosure.70 Twenty companies calculate terminal values with zero growth rates (12% of the 174 companies disclosing growth rate information). A majority of the companies employ long-term growth rates of CGU cash flows falling between 1% and 3%. Interestingly, 24 companies assume (maximum) growth rates of more than 4% in the valuation of some or all of their CGUs containing goodwill; four companies even use growth rates of 7% or higher. In some of these cases, the companies explain that these rates are applied to units active in high-growth product markets or in regions of the world with high growth expectations or high inflation rates. Such rates would appear questionable if employed as eternal growth rates for CGUs located in European markets where long-term growth prospects are modest and inflation rates are generally rather low. Finally, we do not detect any systematic relationship between industry or country of domicile and the growth rates applied in the estimation of terminal values.71

35

46

1913

4 3 4

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05

101520253035404550

0 %

0.01 t

o 1 %

1.01 t

o 2 %

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o 3 %

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o 4 %

4.01 t

o 5 %

5.01 t

o 6 %

6.01 t

o 7 %

> 7 %

no pr

ecise

perce

ntage

disc

losed

Fig. 33 Application of value-in-use method: Maximum reported long-term growth rates of expected cash flows in 2005

Another 20 companies provide explanations regarding calculation of the terminal values and the underlying long-term growth assumptions but do not report numerical values for growth rates or ranges of rates. Several companies only explain that their growth rates equal the rate of inflation, state they use the “long-term expected growth rate for the industry”, or refer to “growth forecasts in industry reports” or to sector-specific measures, without specifying the precise values of the growth rates. Finally, some companies appear to estimate CGU terminal values based on multiples or on other specific and sometimes difficult to understand models.

70 When companies report more than one growth rate, or ranges of growth rates, the highest reported rate is utilised in our analysis. Several companies use discounted-cash-flow models with three phases, a first phase with detailed cash flow forecasts, an intermediate second phase with a relatively high (and sometimes declining) growth rate, and a third phase covering the remaining life of the CGUs with lower growth rates or no expected growth. In these cases, our analysis utilises the growth rates for the third, final phase. 71 However, there appears to be a relationship between industry and country and the propensity to disclose information on CGU long-term growth rates. More precisely, while the overall proportion of companies that employ value in use and disclose the required growth rate information is 63.3%, this ratio is considerably lower for companies operating in banking, insurance, other financial services and basic materials. From a country perspective, disclosure in this respect appears to be relatively weak for Spanish, Hungarian, Czech and Austrian companies.



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Value-in-Use Concept: The Discount Rate In addition to expected future cash flows, the interest rate applied to discount the cash flows to their present value is a key parameter for valuation models. The lower the interest rate, the higher the net present value of a given cash flow stream, and visa versa. Even small changes in the discount rate employed can have substantial effects on the estimated value of a CGU. This holds particularly true if the CGU’s cash flows are expected to increase significantly over long planning horizons.

In the standard discounted-cash-flow valuation model, expected cash flows are discounted with a rate reflecting the risk level of the project or the business.72 Therefore, the appropriate discount rate is the opportunity cost of financing the project, or, in other words, a rate of return “investors would require if they were to choose an investment that would generate cash flows of amounts, timing and risk profile equivalent to those that the entity expects to derive from the [CGU]”.73 The discount rate should reflect the level of risk associated with the CGU which might differ from that of the company as a whole. Thus, using the same discount rate to value all CGUs of a company could introduce bias if the CGUs are active in different markets with different risks.74

Finally, to measure the true contribution of an asset or a CGU to the value of a company, taxes are considered. If taxes are deducted from the CGU’s expected pre-tax cash flows, they should also be incorporated into the discount rate.75 Ideally, the valuation should consider all tax consequences on both a corporate and investor level. However, since the individual tax conditions of investors are often not known when conducting the appraisal, standard valuation models normally only incorporate corporate taxes.76

IAS 36 (para. 55) explicitly requires companies to use a pre-tax discount rate in the valuation of assets or CGUs in the context of impairment testing.77 In the Basis for Conclusions, the IASB explains that discounting pre-tax cash flows at a pre-tax discount rate should give the same result as discounting post-tax cash flows at a post-tax discount rate, “as long as the pre-tax discount rate is the post-tax discount rate adjusted to reflect the specific amount and timing of the future tax cash flows”.78 Although true in principle, this may lead to serious practical problems. In practice, observable interest rates in capital markets are always impacted by taxes, and adjusting post-tax rates to reflect pre-tax rates as required by the standard is highly complex.79

As previously explained, 220 companies, or 80% of all sample companies employing value-in-use models to estimate recoverable amounts of CGUs containing goodwill, disclose the discount rates applied in their valuations. Similar to disclosures associated with planning horizons and growth rates, companies report a wide range of discount rates, with differences arising both between companies and within companies for different CGUs.

72 In principle, it is also possible to adjust the expected cash flows of a project, a CGU or a company with respect to risk level. In such cases, where so-called security equivalents are used in the numerator of the Discounted Cash Flow formula, the appropriate discount rate to be used in the denominator is a risk-free rate of return. 73 See IAS 36 (para. 56.); for more detail also see Appendix A to IAS 36 (paras. A15 to A21). 74 Conceptually, a company’s cost of capital can be interpreted as a weighted average of the costs of capital of all its projects, or CGUs. 75 The discount rate reflects the investors’ opportunity cost for financing the project, that is, the rate of return on an alternative investment. To prevent bias in the valuation, taxes due on returns from the alternative investment are taken into account. 76 Interestingly, a recently revised standard by the German Institute of Auditors (IDW) requires that investors’ income taxes be considered in valuations of businesses. For details, see IDW (2005), Grundsätze zur Durchführung von Unternehmensbewer-tungen (IDW S1), October 2005. 77 Furthermore, para. A20 of Appendix A to IAS 36 requires that the discount rate be adjusted to reflect a pre-tax rate “if the basis used to estimate the discount rate is post-tax”. 78 See IAS 36 (BCZ 85). 79 See Breitenstein, U. / Hänni, C. (2005), Impairment-Tests und der Pre-Tax-Diskontsatz nach IAS 36, in: Der Schweizer Treuhänder 9/2005, pp. 650-657; Lienau, A. / Zülch, H. (2006) , Die Ermittlung des value in use nach IFRS, in: KoR 5/2006, pp. 326-327.



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Figure 34 summarises the disclosed discount rates. Given the heterogeneous format of disclosure, assumptions are needed to aggregate the data. When companies report more than one discount rate or ranges of rates, our analysis is based on the lowest rate disclosed. Furthermore, several companies present details on both pre-tax and post-tax discount rates used in the valuation of CGUs. Most companies, however, do not explicitly state whether the discount rates or ranges of rates reported are pre-tax (or post-tax).

The differences between pre-tax and post-tax discount rates are often considerable. For instance, one company explains that the pre-tax rate is 12%, while the post-tax rate is 9%; another company reports a range between 8% and 11% for pre-tax discount rates and a range between 6% and 7% for post-tax rates. In these cases, in accordance with IAS 36, our analysis is based on the disclosed pre-tax discount rates.

As illustrated in Figure 34, a wide span of (minimum) discount rates is used by our sample companies, ranging from a minimum of 4% to a maximum of 34%, with high proportions of the companies employing rates between 7% and 9%. Discount rates do not appear to be associated with industry or country of domicile in any obvious, systematic way. This may be due to the idiosyncratic, firm- or indeed CGU-specific nature of the discount rates.

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Fig. 34 Application of value-in-use method: Minimum reported discount rates in 2005

Another possible explanation for the absence of any apparent country- or industry patterns might be the heterogeneous format of the disclosures provided. First, some companies report a single discount rate that applies to all CGUs containing goodwill; others report ranges of values for different business units or geographical segments. For example, the highest discount rate reported is 34% and is applied by an Italian utilities company with respect to the impairment test of goodwill from an acquisition in Brazil.

Second, some discount rates are related to specific variants of the discounted-cash-flow method. For instance, a Danish retail & consumer goods company reports a rate of 4% as the minimum rate applied in the impairment testing of goodwill from acquisitions in Western Europe. However, as explained in the financial statement footnotes, this company incorporates all business risks in its cash flow forecasts. The discount rate, therefore, is a risk-free rate that is only adjusted for the political risks of the different geographic segments (which are very low in Western Europe). Another company reporting a very low



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discount rate of 4% uses deflated cash flow forecasts so the discount rate excludes the expected rate of inflation.80

Third, as noted above, some companies distinguish pre- and post-tax rates, while the majority do not indicate whether the rates reported are pre-tax or post-tax. Hence, we – and other outside users of financial statements – cannot ascertain whether the disclosed rates are in fact pre-tax rates. Moreover, given “textbook valuation models” require the application of post-tax rates and the wide span of discount rates reported by our sample companies, we believe it is likely that some of the companies are actually reporting post-tax discount rates.

For the above reasons, the aggregation of discount rates depicted in Figure 34 should be interpreted with great caution. Obviously, outside analysts are confronted with very similar problems when comparing different companies’ disclosures and trying to assess the rigor and validity of companies’ goodwill impairment tests. It appears more guidance on how impairment tests should be applied and on the specific information that should be disclosed in the footnotes would be helpful to produce the transparency the IASB desires in the area of merger accounting.

Sensitivity Analysis of Impairment Test The final part of our study focuses on the disclosure of a sensitivity analysis of the goodwill impairment testing as prescribed by IAS 36. Companies are required to analyse, with respect to each CGU containing a significant portion of the company’s overall goodwill position the effect associated with changes in the key assumptions underlying the valuations.

Specifically, IAS 36 (para. 134 (f)), states that a company should disclose the following information if

“a reasonably possible change in a key assumption on which management has based its determination of the unit’s … recoverable amount would cause the unit’s … carrying amount to exceed its recoverable amount

– the amount by which the unit’s (group of units’) recoverable amount exceeds its carrying amount – the value assigned to the key assumption – the amount by which the value assigned to the key assumption must change, after incorporating any

consequential effects of that change on the other variables used to measure recoverable amount, in order for the unit’s (group of units’) recoverable amount to be equal to its carrying amount.”

This disclosure requirement aims to provide financial statement users with information that allows them to assess the reliability of a company’s valuations regarding goodwill. However, the disclosure is provided by only a very small minority of companies. Only twelve companies (4% of the 347 companies with goodwill on their balance sheets) disclose the details of sensitivity tests including the amounts by which key assumption values have to change for the CGU’s recoverable amount to equal its carrying amount.

A likely reason why only a small number of companies provide sensitivity information is that many companies’ reporting systems are not routinely geared to produce such data. Another likely reason is the conditional nature of the disclosure requirement: The information is only required for CGUs allocated a significant amount of goodwill in relation to the company’s total goodwill position and, second and most importantly, the information is only required if it is “reasonably possible” that a change in the key assumptions of the valuations would cause the CGU’s carrying amount to exceed its recoverable amount.

80 When companies employ specific valuation models, detailed explanations of this nature are necessary. In the absence of such explanations, external users of the financial statements might indeed question the reliability of what could be viewed as extreme and unreasonable rates.



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While we would expect that key assumption changes of this nature would often be “reasonably possible”, in practice this interpretation is subject to judgement. Thus, companies’ managements have scope to decide whether to supply the information and accordingly appear in most instances to be viewing disclosure of a sensitivity analysis as “voluntary”. Analysts and other outside users of financial statements are, however, usually not in a position to evaluate whether or not the disclosure should be required by IAS 36. We believe that, in line with disclosures provided by a small number of sample companies, when sensitivity analysis disclosures are not provided, in the interest of transparency, companies should provide a rationale for omitting the disclosure.


Summary and Conclusions

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E Summary and Conclusions

Background of Study Beginning in 2005, European Unions exchange-listed companies were required to publish IFRS consolidated financial statements following the European Union’s IAS regulation from July 2002. Thus, several thousand companies migrated from their local GAAP and adopted IFRS for the first time representing a major and indeed unprecedented economic experiment.

One of the most challenging areas within IFRS is “merger accounting”, i.e., the accounting rules companies apply when they acquire other companies. The respective standards (IFRS 3 in combination with revised versions of IAS 38 and IAS 36) are relatively new, and have yielded far reaching changes. Given the high relevance of merger accounting and the relative newness of the respective IFRS standards, there is currently some uncertainty among preparers and financial statement users as to the application and interpretation of these standards. This wide-spread uncertainty provides the background and the motivation for our study.

Methodology and Sample The objective of our study is to ascertain how leading European companies applied IFRS merger accounting in their 2005 financial statements. More precisely, we conduct an in-depth analysis and evaluation of companies’ disclosures related to acquisitions undertaken in 2005 as well as disclosures related to goodwill, other intangible assets and impairment testing.81

Our sample is drawn from a total of the 461 companies listed on the premier segments of the 17 most significant European stock exchanges. We eliminated companies from the sample using US GAAP, with year-ends later than 31 March 2006 and not providing English language IFRS consolidated accounts. After reviewing the annual reports of the remaining 390 companies, we identified 33 that neither report acquisitions for their financial year 2005 nor have goodwill resulting from previous transactions. After eliminating these companies, our final sample consists of 357 companies representing all industries, including banking and insurance. For the financial year 2005, the profile for the average sample company is total assets of € 78.3 billion, revenue of € 13.0 billion (non-financial companies only), and net income of € 1.2 billion.

Acquisitions Undertaken by Sample Companies in 2005 Approximately two-thirds of our sample companies (241 of 357) reported acquisitions during 2005. In total, the companies completed more than 780 acquisitions; 299 of these are reported on individually in the consolidated statements of the acquirers. The other acquisitions are reported in aggregate (112 sets), as allowed by IFRS for individually immaterial transactions. Companies in the service and industrial products sectors engaged in the most intensive takeover activity in 2005, as measured by the average number of acquisitions undertaken per company. From a country perspective, the companies engaging in the most acquisitions are headquartered in Austria, Denmark, Finland and The Netherlands.

The average total acquisition cost for the individually reported transactions is € 512 million. Interestingly, companies voluntarily enhance transparency as many individually reported acquisitions are relatively small; for a majority, acquisition costs represent less than 1% of

81 As 2005 represents the first year of full IFRS adoption for most European listed companies, we do not attempt to identify “best practices” as these will continue to evolve as companies become more familiar with IFRS.



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post-acquisition total assets. However, a few companies aggregate disclosures for acquisitions where aggregate acquisition costs exceed 5% of post-acquisition assets. Some of these acquisitions are likely individually material and should, therefore, potentially be reported individually.

Accounting and Disclosure on 2005 Acquisitions Under IFRS 3, all business combinations are accounted for using the purchase method. Application of the purchase method involves three steps: identifying an acquirer, measuring the cost of the combination and allocating the cost to the assets acquired and the liabilities and contingent liabilities assumed (purchase price allocation - PPA). In the financial statement footnotes, companies are required to provide extensive information on the components of the cost of the business combination and about the PPA. The vast majority of companies disclose the cost of their acquisitions (purchase price). However, one-third of the companies do not provide the required description of the components of the cost of the business combination, which is to include the “costs directly attributable to the combination”, e.g., fees paid to accountants, legal advisers, consultants etc.

Regarding PPA, about one-fourth of the companies do not provide information regarding the classes of acquired assets, liabilities and contingent liabilities. In other instances, information on PPA is provided but is scant in content, i.e., only one or two classes of assets or liabilities are explicitly distinguished. Disclosure on PPA is particularly deviating in the insurance and banking industries; for both sub-samples, less than half of the companies of the overall sample provide all of the required information.

Our analysis also reveals that most companies provide information for only one class of intangible assets. Information on two or more classes of intangibles is represented only for a relatively few number of cases. Furthermore, contingent liabilities are rarely recognised as part of PPA. Of the 299 individually reported acquisitions and the 112 aggregated sets of acquisitions reported by our sample, contingent liabilities are reported in only four cases. We pose the question as to whether this is due to the scarcity of contingent liabilities in practice or alternatively to varying interpretations regarding the application and rationality of this IFRS reporting requirement.

The great majority of acquisitions undertaken by our sample in 2005 led to the recognition of goodwill. Interestingly, in most cases the values assigned to goodwill represent 50% or more of the total cost of the acquisitions. Our analysis further reveals that the relative importance of goodwill varies greatly by industry, with acquisitions in the entertainment & media industry on average leading to the highest ratio of goodwill to total cost of the acquisition.

A rationale for the recognition of goodwill as required by IFRS 3 is provided by about 40% of the companies. Furthermore, those providing this disclosure in general only vaguely refer to expected synergy effects and growth expectations. Finally, less than one-quarter of the companies provide the required acquisition-related pro-forma disclosures, i.e., revenue and profit or loss of the combined entity for the complete year as if the acquisition dates for the business combinations completed during the period occurred at the beginning of the year. Additionally, very few of the companies not disclosing pro-forma information refer to this fact and explain why supplying the disclosure is impracticable.

Our analysis of M&A disclosures reveals that adoption of IFRS throughout Europe in 2005 resulted in new and extended disclosure requirements that provide financial statement users with useful insight regarding what has actually been acquired. As companies become more accustomed with IFRS, our view is that best practices will emerge along the lines discussed below, thereby, leading to further enhanced transparency and comparability.



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Total Goodwill Balances We also examine the overall goodwill balances of our sample companies, i.e., goodwill resulting from 2005 acquisitions as well as from acquisitions undertaken in prior periods. It is important to note in this context that, preceding the adoption of IFRS, the national GAAP of some European countries allowed companies the option of charging goodwill directly to equity. Hence, the opening IFRS statements of some IFRS first-time adopters in our sample had zero balances for goodwill (even if the company had engaged in significant M&A activity in previous periods) thereby making comparisons of goodwill-related key figures problematic.

Our findings emphasise the high relevance of goodwill and other intangible assets for the companies comprising our sample. The average total intangibles balance is € 3.8 billion, with a substantial portion – € 2.5 billion – being attributable to goodwill. Approximately 20% of our sample (74 companies) reports intangible assets assigned indefinite useful lives (other than goodwill) on their balance sheets or provide detailed disclosure in their notes. The average balance for those intangible assets is € 0.8 billion.

The telecommunications industry by far has the largest average balance for total intangible assets (€ 12.6 billion) with a large portion again being attributable to goodwill (€ 8.3 billion). These large goodwill balances are due to numerous “mega mergers” that occurred in this industry over the past decade.

Goodwill balances, on average, represent approximately 40% of total shareholders’ equity. For some companies, goodwill even exceeds equity. Thus, a significant number of sample companies appear very vulnerable to potential future goodwill impairment charges.

The relative importance of goodwill varies by industry and country. The entertainment & media industry has by far the highest exposure with goodwill on average almost equaling shareholders’ equity (97%). From a country perspective, Dutch and UK companies have the highest goodwill-to-equity ratios. Not surprisingly, goodwill represents a much lower proportion of net assets on the balance sheets of Polish, Czech and Hungarian companies.

Impairment Losses in 2005 Of the 357 European blue chips comprising our sample, approximately 70% report impairment losses for 2005. Of these, 64, 60, and 122 report impairment of tangible assets only, intangible assets only, and impairment of both tangible and intangible assets, respectively. More specifically, about one-third of the sample companies recognise impairment charges associated with goodwill; the average charge to net income is € 358 million. UK and German companies stand out as reporting the highest average goodwill impairment charges during 2005 at € 1.9 billion and € 0.5 billion, respectively. This is associated with very high impairment losses reported by telecommunications and utility companies.

The number of companies reporting impairment of intangible assets with definite lives is similar to that that reporting goodwill impairment. However, the average loss is much lower at € 38 million. Finally, impairment of intangible assets assigned indefinite lives, in comparison, is a rather rare occurrence (eight companies representing slightly over 10% of the 74 reporting such assets; average charge: € 41 million).

Goodwill Impairment Testing: Overall Results Our analysis focuses on goodwill impairment testing practices. The objective is to determine the method(s) utilised by companies to allocate goodwill to cash-generating units (CGUs), when companies conduct impairment tests, whether companies compare the carrying amounts of the CGUs containing goodwill with ‘fair value less costs to sell’ or



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with ‘value in use’ or a combination of both and how companies estimate the respective values for the recoverable amount.

About two-thirds of the companies with goodwill balances voluntarily disclose the total number of CGUs containing goodwill. For most companies, goodwill is concentrated in a small number of CGUs. Most companies allocate goodwill to CGUs utilising the highest hierarchical level allowed by IFRS, e.g., the primary or secondary segment reporting format.

For most accounting departments and auditors year-end is a time of extreme work loads and time pressure. Thus, companies would be expected to shift time-consuming tasks such as goodwill impairment testing to other time periods, if possible. In addition, goodwill impairment testing relies on forward-looking information contained in a company’s mid- to longer-term financial and business plans. Thus, to prevent unnecessary replication of work it appears logical that companies would coordinate the timing of impairment testing with the company’s planning cycle. Although preparers are provided the flexibility of choosing the date for the recurring annual goodwill impairment test, most sample companies perform this test at, or shortly before, the balance-sheet date. None of the companies explicitly indicate that additional impairment testing was conducted during 2005 in response to triggering events.

Over 80% of the companies with goodwill balances disclose the method used to measure the recoverable amount of CGUs containing goodwill. Most of these utilise the value-in-use concept either exclusively (68%) or in conjunction with fair value less costs to sell (11%). A majority of these companies also provides all required IFRS disclosures with respect to value-in-use estimations for CGUs containing goodwill. However, a significant number of the companies in the sample do not provide all the prescribed disclosures, and some do not provide any of the required IFRS disclosures.

For companies employing the value-in-use concept to determine the recoverable amount of CGUs containing goodwill, the cash-flow planning horizon varies greatly, not only between companies but also within companies for different CGUs. The same holds true for the growth rates underlying the calculations of terminal values and the discount rates applied in the valuations. For example, a wide span of discount rates is used, ranging from 4% to 34%, with high proportions of companies employing rates between 7% and 9%. Some companies distinguish pre- and post-tax rates. The majority, however, does not state whether the discount rates or ranges of rates reported are pre- or post-tax. While some companies precisely disclose key parameters per CGU, others only provide summary ranges of planning periods, growth rates and discount rates.

Finally, only 12 companies (4%) with goodwill balances disclose sensitivity tests including the amounts by which key assumptions need to change for a CGU’s recoverable amount to equal its carrying amount. We posture that the relative low level of disclosure is likely associated with the conditional nature of these disclosure requirements, e.g., IAS 36 requires disclosure only if it is “reasonably possible” a change in the key assumptions of the valuations would cause the CGU’s carrying amount to exceed its recoverable amount.

IFRS Merger Accounting and Disclosure 2005: Overall Conclusions Our empirical analysis yields a rich set of detailed information on the practices of leading European companies in the area of merger accounting and disclosure. Based on a careful, comprehensive evaluation and consideration of the findings, the following represents our overall interpretation of the findings in regard to the 2005 application of merger accounting by our sample companies.

First, we stress that our findings should be considered in light of the fact that, for the majority of sample companies, 2005 represents their first year of full IFRS adoption. This paradigm shift, in most cases from their local GAAPs, represents a major hurdle. Of



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particular relevance, the new standard IFRS 3 and the revised versions of IAS 36 and IAS 38 were issued on 31 March 2004 and accordingly were relatively new thereby allowing relatively little time to prepare for their application in the 2005 consolidated financial statements. Accordingly, all the sample companies, including those that followed IFRS prior to 2005, not only had no experience with applying IFRS 3 and the two revised standards but additionally there were no best practice models, interpretations or other forms of application guidance available to assist them. Compounding the challenge, the final version of these three standards deviated materially from the EDs preceding them. In addition to the onerous merger accounting requirements, all sample companies had to implement a significant number of other new or revised standards resulting from the IASB’s Improvement Project

Given these obstacles to implementing IFRS merger-related accounting rules, our analysis of the surveyed companies indicates a substantial achievement by the companies and should be applauded. Based on our detailed review of the financial statement footnotes, it appears that a majority of the leading European companies comprising our sample in general successfully navigated the transition to IFRS and the application of IFRS merger accounting in particular.

Avenues for Improvements in IFRS Merger Accounting and Disclosure Given that many sample companies applied IFRS for the first time in 2005, and given further the complexity of merger accounting and disclosure, it comes as no surprise that our analysis uncovered areas where for many companies improvement is feasible. Recapitulating, we highlight three avenues for future improvements in the application of IFRS merger accounting and disclosure.

(a) Improving compliance Our study reveals that the majority of our sample companies fulfil most merger and goodwill related IFRS disclosure requirements. For some companies, particularly in certain areas, however, there is still room for improvement. As summarised above, compliance with M&A transaction disclosure requirements is often lacking with regard to the components of the costs of business combinations, PPA, acquisition-related pro-forma performance figures and explanations concerning the recognition of goodwill (or badwill). Our study notes additional areas where compliance is less than perfect, e.g., disclosures regarding goodwill impairment tests.

Furthermore, our sample is comprised of the top-tier companies of Europe’s leading stock exchanges and includes many of the world’s largest companies. We believe these companies, with their resources and expertise, should set the benchmark for high-quality financial reporting that other companies across Europe should be encouraged to follow. Our analysis reveals that many of our sample companies have accepted this challenge. However, others still have a way to go to comply fully with IFRS merger-related disclosures.

Finally, transparency necessitates the existence of not only high quality accounting standards but also rigorous enforcement of these standards. In fact, some countries, e.g. in Germany, recently reformed and strengthened their enforcement systems. Therefore, we expect that in ensuing years supervisory agencies across Europe will further increase their efforts to force EU-listed companies to higher standards of IFRS compliance. Additionally, the EU in May 2006 amended its directive on audits of financial statements to



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achieve “a high-level harmonisation of statutory audit requirements” across Europe.82 Among other things, the directive mandates that statutory audits in the EU be carried out on the basis of international auditing standards adopted by the European Commission and that all exchange-listed companies must have an audit committee.83

(b) Improving understandability and information content Second, many companies can enhance transparency and comparability by improving the understandability and information content of existing IFRS disclosures.

In some areas, application of IFRS requires judgement by both the companies’ managements that are responsible for the preparation of the financial statements and their auditors. For instance, IFRS do not explicitly state when acquisitions are “individually immaterial”, thereby allowing aggregate disclosure in accordance with IFRS 3 (para. 68). Also, IFRS do not prescribe the minimum number of classes of the acquiree’s assets, liabilities and contingent liabilities for which the amounts recognised are to reported following IFRS 3 (para. 67 (f)). Furthermore, judgement by financial statement preparers determine whether contingent liabilities are recognised based on IFRS 3 (paras. 37 and 47). For instance, if such liabilities exist, management determines whether or not their fair value can be measured reliably. Similarly, ultimately management decides, inter alia, how insightful to make the explanation of the reasons leading to the recognition of goodwill, the detail and precision of information disclosed on the valuation methods used in impairment tests, and whether to disclose sensitivity tests for the valuation of CGUs. For example, our analysis reveals that,

● a few companies report individually large acquisitions in aggregate with other M&A transactions;

● some companies disclose only very limited and vague information on the assets

acquired and liabilities assumed through acquisitions - sometimes only one or two classes of assets or liabilities are distinguished;

● only in a very few instances do companies report on the recognition of assumed

contingent liabilities, thereby, leading us to wonder whether assumed contingent liabilities can possibly be this rare in practice;

● few companies provide descriptions of the factors leading to the recognition of goodwill,

and for those providing this disclosure, some of the explanations are vague and limited in information content;

● with respect to goodwill impairment tests, some companies only disclose ranges of

planning periods, growth rates and discount rates used in the determination of the recoverable amounts of CGUs, without specifying the key assumptions used for a specific CGU;

● very few companies disclose information on sensitivity tests for CGU valuations, thereby,

leading us to consider whether some companies utilise the somewhat “optional” nature of this requirement to sidestep disclosure;

Application of professional judgement allows management some flexibility, and quite possibly most of the analysed companies comply with the letter of IFRS fully. However, we

82 See Directive 2006/43/EC of the European Parliament and of the Council of 17 May 2006 on statutory audits of annual accounts and consolidated accounts, amending Council Directives 78/660/EEC and 83/349/EEC and repealing Council Directive 84/253/EEC; Official Journal of the European Union, L 157/87, 9.6.2006. 83 See Tiedje, J. (2006), Die neue EU-Richtlinie zur Abschlussprüfung, in: Die Wirtschaftsprüfung, Vol. 59, No. 9, S. 593-605; Naumann, K.-P. / Feld, K.-P. (2006), Die Transformation der neuen Abschlussprüferrichtlinie, in: Die Wirtschaftsprüfung, Vol. 59, No. 14, S. 873-885; .Woolfe, J. (2005), Auditing looks stronger as EU adopts int’l standards, in: Accounting Today, Vol. 19, No. 18, pp. 3-21; Bolton, L. (2006), Déjà vu, in: Accountancy, Vol. 138, No. 1359, pp.82-83.



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believe that at times the resulting disclosures do not adhere to the spirit of IFRS. In the future, companies should aim to provide users with sufficient information that truly enables them to “evaluate the nature and financial effect of business combinations” (IFRS 3, para. 66), evaluate the reliability of goodwill and other valuations, and assess the rigor of impairment tests.

Sometimes, a small change in presentation can yield clearer, more useful disclosures, e.g., adding explanations, using tabular presentations of key assumptions for specific CGUs, explaining why providing certain disclosures are impracticable. In these cases, companies, with relative ease, can develop best practice or industry practices based on analyses and comparisons of peer companies’ financial statements. In other areas, however, development of best practice disclosures will likely require more effort, affecting not only presentation but also recognition and valuation practices, e.g., the degree of detail and precision of PPA, recognition of contingent liabilities and application and disclosure of sensitivity analyses. We anticipate that given the high relevance of merger accounting and goodwill-related disclosures such efforts directed at improving the understandability and information content of existing IFRS disclosures will be well received by investors, analysts and other financial statement users.

(c) Improving consistency and comparability Our third conclusion specifically addresses the consistency and comparability of M&A related disclosures. After carefully analysing many sets of M&A disclosures, we believe that most companies currently fulfill most IFRS accounting and disclosure requirements. However, the information presented is often not as transparent as possible to investors, analysts and other users. This is because companies vary in their interpretation of IFRS and thus account for, or disclose, the effects of the transactions and other events in different ways. Consequently, it is often difficult and sometimes even impossible for outside users to fully comprehend the accounting practices of a given company. Moreover, the resulting heterogeneity of disclosures seriously hinders comparability. For instance, companies even within the same industry use different classifications for assets acquired and liabilities assumed in business combinations, utilise different thresholds to distinguish individually material and immaterial acquisitions (or impairment losses) and apply different valuation methods and different key assumptions for goodwill impairment tests.

While we appreciate that determining the appropriate balance between understandable, concise accounting standards and prescriptive details is a major challenge for the IASB, we encourage the Board to consider providing moderate clarification of a few select areas of merger-related accounting and disclosure to further advance comparability. Two illustrations stemming from our analyses are: firstly, clarifying the conditions for disclosure of sensitivity analyses of goodwill impairment tests or perhaps requiring disclosure unconditionally (or at a minimum, in the absence of disclosure, requiring a statement explaining why disclosure is not merited) and secondly, providing some clarification regarding the application of valuation methods in impairment testing. Concurrently, we suggest that the IASB consider dispensing of a few disclosure requirements that in practice are found as having an unfavorable cost-benefit relationship. This could potentially ease the challenge of IFRS application and accordingly enhance understandability and comparability.

The primary responsibility falls, however, to financial statement preparers, with the assistance of auditors, consultants, analysts and academics to develop best practice guidance of IFRS requirements for the issues highlighted in our report. Such guidelines could be communicated via various formats, for instance by industry associations. Best practices should facilitate consistent and comparable accounting between entities which is in the best interest of investors, analysts and other financial statement users. Furthermore, however, given the complexity and the costs involved in applying current accounting and disclosure regulations, companies using IFRS should have a strong incentive to facilitate and advance such learning processes.


Literature

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Bolton, L. (2006) Déjà vu, in: Accountancy, Vol. 138, No. 1359, pp. 82-83.

Brealey, R. A. / Myers, S. C. / Allen, F. (2006) Principles of Corporate Finance, 8th edition, Princeton (N.J.): McGraw-Hill.

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Jäger, R. / Himmel, H. (2003) Die Fair Value-Bewertung immaterieller Vermögenswerte vor dem Hintergrund der Umsetzung internationaler Rechnungslegungsstandards, in: Betriebswirtschaftliche Forschung und Praxis, No. 4, pp. 417-440.

Lienau, A. / Zülch, H. (2006) Die Ermittlung des value in use nach IFRS, in: KoR 5/2006, pp. 326-327.

Mackenstedt, A. / Fladung, H.-D. / Himmel, H. (2006) Ausgewählte Aspekte bei der Bestimmung beizulegender Zeitwerte nach IFRS 3 – Anmerkungen zu IDW RS HFA 16 –, in: Die Wirtschaftsprüfung, Vol. 59, No. 16, pp. 1037-1048.


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Naumann, K.-P. / Feld, K.-P. (2006) Die Transformation der neuen Abschlussprüferrichtlinie – Erwartungen des Berufsstands der Wirtschaftsprüfer an den deutschen Gesetzgeber –, in: Die Wirtschaftsprüfung, Vol. 59, No. 14, pp. 873-885.

Pellens, B./ Sellhorn, T. (2001) Neue Goodwill-Bilanzierung nach US-GAAP – Der Impairment-Only Approach des FASB –, in: Der Betrieb, Vol. 54, No. 14, pp. 713-720.

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Woolfe, J. (2005) Auditing looks stronger as EU adopts int’l standards, in: Accounting Today, Vol. 19, No. 18, pp. 3-21.


Contact

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Contact Justus-Liebig-Universität Gießen Prof. Dr. Martin Glaum Tel.: +49 641-9922-580 Fax: +49 641-9922-589 E-Mail: martin.glaum@ wirtschaft.uni-giessen.de

Silvia Vogel Wissenschaftliche Mitarbeiterin Tel.: +49 641-9922-587 Fax: +49 641-9922-589 E-Mail: silvia.vogel@ wirtschaft.uni-giessen.de

Lehrstuhl für Internationales Management, Rechnungslegung und Wirtschaftsprüfung Licher Straße 62 35394 Gießen Germany

University of Dayton Prof. Donna L. Street, Ph.D. Mahrt Chair in Accounting Tel.: +1 937-229-2461 E-Mail: [email protected]

300 College Park DAYTON, OH 45469-2242 USA

PricewaterhouseCoopers Andreas Mackenstedt Tel.: +49 69 9585-5704 Fax: +49 69 9585-5960 E-Mail: [email protected]

Dr. Holger Himmel Tel.: +49 69 9585-5871 Fax: +49 69 9585-5961 E-Mail: [email protected]

Marie-Curie-Straße 24-28 60439 Frankfurt Germany

www.pwc.de/en/ma-ifrs-survey2005

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