1. FRC Study: Accounting for Acquisitions, January 2010 Presentation to SSBV Shân Kennedy 1 February 2010

2. Purpose of study To identify areas for improvement in accounting for M&A in context of: –IFRS 3, Business Combinations, introduced 2004 requirement to recognise intangible assets separately from goodwill; and to provide explanation of components of goodwill –analyst comment to date on (lack of) usefulness of information generated by IFRS 3

3. What we did Selected 20 UK listed companies that had made material acquisitions in 2008 –range of different industries –included 3 AIM companies Reviewed their compliance with –IFRS 3, Business Combinations; and –IAS 38, Intangible Assets

4. How big were the amounts involved? Sum of recorded intangible assets and goodwill –greater than the purchase price for half the transactions –equal to the purchase price on average Goodwill alone was approx 2/3 of purchase price on average Intangible assets alone were approx 1/3 of purchase price on average

5. Front of annual report – chairman, CEO, CFO comments clear and consistently good e.g. forward order books, strong brand names, distribution networks, cross-selling synergies Back of annual report – audited accounts unclear or obfuscated benefits from front neither identified as intangible assets nor described within components of goodwill What we found …pantomime cow?? Consistency between front and back in only 4 cases

6. IFRS intangible asset recognition requirements Must recognise intangible assets distinct from goodwill if –the intangible is ‘identifiable’ This means it is either –‘separable’; or –legally secured –but not necessarily both of these

7. Separability of intangible assets Intangible can be sold or licensed independently from the underlying business Need not be capable of separation on its own –e.g. could be together with another intangible asset, a liability or a tangible asset –typical examples - financial services industry

8. Findings of study Two companies had recorded no intangible assets other than goodwill, but….. Fronts of reports had identified several intangible benefits expected from the acquisitions –why were these neither recognised as intangible assets nor disclosed as components of goodwill? –had companies performed effective exercises to ensure all identifiable intangible assets had been recognised?

9. Disclosure issues Each material class of intangible assets to be disclosed separately A class of intangible assets is a grouping of intangible assets of a similar nature and use in an entity’s operations e.g. trade marks, internet domain names, non-compete agreements, customer contracts, contractual and non-contractual customer relationships –see IFRS 3 Illustrative Examples

10. What we found Classes were not disclosed separately for each material acquisition –7 companies displayed classes only in aggregate for all acquisitions that took place in the year confusing for reader to link the clear narrative at front of report with obfuscation in audited accounts difficult to understand what the intangible assets that had been recognised represented

11. Customer-related intangible assets: specific problems 15 companies identified some type of customer-related intangible asset In 2 cases, a class was disclosed comprising the aggregation of brand values and customer relationships –but are these of a similar nature and use in a business? –one may well strengthen over time, whilst the other may suffer attrition 3 companies had disclosed aggregated customer assets –some or all of customer contracts, customer lists and customer relationships Only one company had differentiated customer contracts from customer relationships

12. The class called ‘other’ Disclosed by 7 of the companies 3 included disparate benefits within this one class, in one case, comprised all of –purchased and acquired patents, licences and trade marks, software rights and order backlog – similar nature and use in an entity’s operations…

13. Description of goodwill Only 14 companies made any disclosure at all Of these we classified 5 as uninformative and 9 as slightly informative What we were looking for –description of intangible benefits that failed the identifiability requirement to be separable or legally secured e.g. a team of staff with specific knowledge –explanation of cross-selling synergies and how they arose –cross-referencing to the front of the annual report –i.e. a better understanding of the transaction and how it had been accounted for

14. Impact of new IFRS 3, revised 2008 Must be applied for reporting periods commencing 1 July 09 onwards Key changes affecting intangible asset recognition –all intangible assets arising from an acquisition are capable of reliable measurement –enhanced guidance regarding separability of intangible assets –aggregation of different intangible assets for valuation purposes

15. IAS 38: intangible asset aggregation Para 37 –The acquirer may recognise a group of complementary intangible assets as a single asset provided the individual assets have similar useful lives –e.g. the term brand may be used for a group of complementary assets such as a trademark and its related trade name, formulas, recipes and technological expertise

16. Looking further forwards Fair Value Measurement Exposure Draft Reliability hierarchy of valuation inputs Sensitivity analysis for valuations assessed as Level 3 Many valuation definitions that will apply to all valuation exercises –market participants, fair value, principal market and most advantageous market IFRS expected Q3 2010

17. FRC Study: Accounting for Acquisitions, January 2010 Presentation to SSBV Shân Kennedy 1 February 2010