Non-current assets

IAS 16.56 outlines four criteria ("factors") for determining useful life.

The first should be used if possible, while the remaining three should be applied as appropriate.

1. expected usage (a.k.a. units of production)
2. physical wear and tear
3. technical or commercial obsolescence
4. legal or similar limits

To establish residual | salvage value in practice, a company will generally use its historical experience.

For example, if it commonly sells class A machines for an average of 10% or their acquisition cost and class B machines for 20%, it would set residual | salvage values of 10% and 20% respectively.

It is also possible to estimate using observable inputs in a manner consistent with IFRS 13.67 | ASC 820-10-35-36.

For example, a company could determine the average price comparable assets bring at auction (although a quick and dirty internet search is often good enough).

However, in practice, sticking to the 10% to 20% rule of thumb is often the best option.

Although not setting a residual | salvage for assets that are eventually sold (demonstrating that they had residual | salvage value) would be an error, if would rarely be sufficiently material to trigger a restatement as outlined in IAS 8.42 | ASC 250-10-50-12.

Caveat: intentionally failing to establish residual | salvage in situations where residual | salvage demonstrably exists to achieve a particular end would always be material as outlined in IAS 8.41 | ASC 250-10-S99-1.2

Note: the only way to correct errors is retrospectively, in this case going back to the period the asset was acquired.

Also note: even if the correction of an intentional error is not sufficiently material to warrant a restatement of the financial statements, the error would still need to be disclosed and reported to the pertinent market regulator.

For example, some time ago a Czech company decided to list on a US exchange.

After retaining an underwriter, the underwriter retained us to draft a report consistent with US GAAP.

As, unlike CZ GAAP, US GAAP distinguishes revenue/gains and expenses/losses, this was one the first adjustments.

After reviewing our preliminary results, the underwater decided against pursuing a listing.

As outlined in IAS 38.54, research costs may never be capitalized.

As outlined in IAS 38.57, development may be capitalized but only if the resulting asset can be sold or used.

As patents are unique, it is difficult to demonstrate that a market for the patent or the output of the patent (the product or service) exists.

In contrast, if the patent covers improved technology for an existing product or service (or some other useful internal purpose), capitalizing its development is fairly straightforward.

As outlined in IAS 38.107 | ASC 350-30-35-15, intangible assets with indefinite lives are not amortized.

Because indefinite is transitory, indefinite should not be confused with infinite, unlimited, indeterminate or undeterminable (IAS 38.91 | ASC 350-30-35-4).

From a practical, accounting perspective this means assets with indefinite lives, while not amortized or depreciated, are tested for impairment at least every period.

In contrast, assets with unlimited lives, for example land, while also not depreciated or amortized, do not need to be regularly tested for impairment (IAS 38.108 | ASC 350-30-35-16).

Both IAS 38.108 and provide ASC 350-30-35-16 relatively straight forward guidance, requiring assets with indefinite lives (not being amortized) to be tested for impairment annually (sooner if there is an indication they are impaired).

In a minor difference, ASC 350-30-35-17A prohibits acquired in-process R&D from being amortized until the project is completed (and useful life is determined) or the project is abandoned (and the asset is written off). Neither IFRS 3 nor IAS 38 provides similar guidance.

Additional guidance (IAS 38.108 | ASC 350-30-35-18A) stipulates that a review | qualitative assessment should be performed.

Note: the qualitative assessment in US GAAP is relatively involved. Paragraphs 350-30-35-18B through 35-18F outline how exactly it should be performed.

For its part, IAS 38 does not provide similarly detailed guidance. IAS 38.110 simply refers to IAS 36.

Interestingly, while both US GAAP and IFRS use the term consideration, neither define it.

This is not because its general meaning is unclear: it is the cash (or something of value like shares) paid in a transaction for something else of value (a product, service or, in this case, a company).

It is because its precise meaning is surprisingly difficult to pin down.

For example, entering "consideration" into Black's online law dictionary (link: thelawdictionary.org) brings up a blank page while Britannica (link: britannica.com), although it does define it, quickly goes off on a tangent about, among other things, love and affection.

Fortunately, a quick google search (link: google.com) quickly brings up perhaps the best definition (link: law.cornell.edu).

As outlined in IFRS 3.3 | ASC 805-10-25-1, goodwill may only be recognized if the acquired entity is a business. Otherwise, the acquisition is treated as an asset acquisition.

While inputs and a process are essential elements of a business, "outputs are not required for an integrated set to qualify as a business" (IFRS 3.B7 | ASC 805-10-55-4).

"However, to be considered a business, the set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output" (IFRS 3.B8 | ASC 805-10-55-5).

This implies, if an acquired operating unit only produced goods for other operating units, whether or not it had actual outputs (goods sold to unrelated, third parties) is beside the point. Whether it is capable of having these outputs is the point.

Note: while acquisition announcements generally cause significant swings in share price, by the time the acquisition closes, the market has priced in its impact, giving a fair representation of fair value.

IFRS 3 | ASC 805 defines continent consideration: Usually an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. However, contingent consideration also may give the acquirer the right to the return of previously transferred consideration if specified conditions are met.

Additional guidance is provided in IFRS 3.39 and 40 | ASC 805-30-25-5 to 7.

In the past, if shares instead of cash were used to fund the acquisition, goodwill was not recognized.

Under current guidance, it makes no difference if the acquirer paid with cash, its own shares, or a combination.

Options and warrants are similar in that they convey the right the purchase equity instruments.

They differ in that options are generally issued by an investor that holds the company’s shares, while warrants are issued by the company itself.

As a result, funding an acquisition with options does not create new equity for the acquirer.

Warrants and options and are similar in that they convey the right the purchase equity instruments.

They differ in that warrants are issued by the company itself, while options are generally issued by an investor that holds the company’s shares.

As a result, funding an acquisition with warrants creates new equity for the acquirer.

Identifying, recognizing and measuring previously unrecognized assets (previous illustration) is not (usually) particularly difficult.

In contrast, identifying liabilities, especially those the acquired company's management may have gone out of its way to not disclose, is better left to experts (such as former FBI agents who left the agency due to its strict retirement policies) skilled wielding instruments not generally found in any accountant’s toolbox.

It is important to note that responsibility is jurisdictional.

In the United States, section 302 of the Sarbanes Oxley act specifies the CEO and CFO are responsible for the company’s financial reports.

Obviously, they can rely on additional individuals, for example a chief accountant or controller who certifies the company’s accounts are SOX compliant. However, to “pass down” SOX responsibility, the CEO and CFO must be sure they are relying on individuals with sufficient professional expertise to understand the repercussions of certifying the company’s SOX compliance.

This implies, even if a chief accountant did certify that the acquiring company has recognized, measured and disclosed all the acquired company's liabilities, unless his skill set includes forensic audit, it is unlikely this certification will be sufficient to absolve the CEO and CFO of their SOX responsibility.

In contrast, IFRS is applied in various jurisdictions with varying requirements.

For example, in some EU member states, if a company employs the services of a court certified valuer, the valuer, not company’s officers, bear the responsibility for the content of the valuer’s report.

In such a jurisdiction, if the court certified valuer’s report outlines the assets acquired and liabilities assumed in a business combination, this report, not the judgment of the company’s accounting department, serves as the basis for recognition and measurement of those assets and liabilities.

When IFRS it applied in such a jurisdiction, that jurisdiction's rules and regulations may determine how IFRS is applied.

In a real-world example, company A acquired company B. Company B was domiciled in a jurisdiction where the acquisition price needed to be certified by a court appointed valuer.

Company B then used this valuer’s report to draft an "IFRS compliant" financial report. This report was certified by a statutory auditor licensed to express its opinion in this jurisdiction because, from the perspective of that jurisdiction’s legislation, the report was consistent with IFRS.

In an attempt to save time and effort, company A simply took this IFRS report and, with no significant adjustments (and in the belief IFRS and US GAAP were comparable), recognized the assets and liabilities it included.

However, as company A's shares were listed on a US exchange, its financial report was then reviewed by a US certified public accountant.

Rather than accept a qualified auditor's report (and risk a possible SOX compliance review), company A discarded company B's IFRS report and spent the next three months creating a report consistent with US GAAP.

The result?

What had been originally been bargain purchase, was magically transformed into an acquisition with goodwill (not in the same amount).

While some of the difference was due to inadequately measured assets, most was caused by liabilities not fully captured in the original valuer’s report.

While IFRS 3.34 to 36 | ASC 805-30-25-2 to 4 specify that a bargain purchase is possible, in practice it generally means the acquirer did not correctly measure the acquiree's assets and, much more likely, failed to identify and measure all the acquiree's liabilities, especially provisions and contingent liabilities.

For this reason, as outlined in IFRS 3.36 | ASC 805-30-25-4, before recognizing any bargain purchase gain, it is imperative the acquirer repeat due diligence (this time thoroughly).

As recognizing a bargain purchase gain is practically never justifiable no illustrate is provided.